Question

Rivoli Inc. hired you as a consultant to help estimate its cost of capital. You have been provided with the following data: D0 = $0.80; P0 = $57.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Answer 1

Answer:

9.5%

Explanation:

The formula to compute the cost of common equity under the DCF method is shown below:

= Current year dividend ÷ price + Growth rate

In first case,  

The current dividend would be  

= Last year dividend + last year dividend × growth rate

= $0.80 + $0.80 × 8%

= $0.80 + $0.064

= $0.864

The other things would remain the same

So, the cost of common equity would be

= $0.864 ÷ $57.50 + 8%

= 0.015026 + 0.08

= 9.5%