Question

You’ve collected the following information from your favorite financial website.

Answer 1

Answer:

-9.92%

Explanation:

P₀ = Div₁ / (Re - g)

• Div₁ = next year's expected dividend = $1.12 x (1 - 11.5%) = $0.9912
• Re = cost of equity = ?
• P₀ = current stock price = $62.91
• g = dividend's growth rate = -11.5%

Re =  (Div₁ / P₀) + g

Re = ($0.9912 / $62.91) - 11.5%

Re = 1.58% - 11.5% = -9.92%

Since the cost of equity or required rate of return cannot be negative, I suppose that investors are not worried about Abbott distributing dividends, instead, they prefer that the company reinvests earnings in new projects.