Reference no: EM132597247
Cost of common stock:
Question 1: Whitewall Tire Co. just paid a $1.60 dividend on its common shares. If Whitewall is expected to increase its annual dividend by 2 percent per year into the foreseeable future and the current price of Whitewall's common shares is $11.66, what is the cost of common stock for Whitewall?
We can estimate the cost of common stock several ways, including the Capital Asset Pricing Model (CAPM), the Constant-Growth Dividend Model, and the Multi-stage Growth Divident Model. In this case, I will use the Constant-Growth Dividend Model. The problem indicates that Whitewall is expected to increase its annual dividend by 2% per year, for the foreseeable future. As explained in the text, if the dividends received by the owner of a share of common stock are expected to grow in perpetuity, the value of the share can be calculated using the constant-growth dividend model.
D1= dividend expected to be paid one period from today 1.60 x (1 + 0.02)
R= required rate of return
.g=annual rate at which the dividends are expected to grow in perpetuity
Replace R with kcs because we are looking at estimated expected rate of return for common stock. Formula is now as follows to solve for kcs
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