Question

What are the steps to solving this problem? Beginning to end?

13. ABC Corp. has a share price of $10 today. The company is not expected to pay a dividend in one year, but in two years (time 2) it is expected the ABC will pay dividend of $0.50 and its stock price will be $12. What is ABC Corp.'s equity cost of capital? (Hint: the current price is equal to the PV of of Div2 and P2 discounted by the equity cost of capital.) A. 9.5% B. 11.8% C. 20.0% D. 25.0% Solution: Price today equals the PV of future cash flows, thus 10 = 0,50+32 Śre = 0.118

Answer 1

Price Today Dividend Received in Year 2 = Share Price in Year 2 10.00 0.50 12.00 Total cash flows in year 2 0.50-12.00 12.5 Present value 10 = 11 11 (1+r)^2 (1+r)^2 (1+r) (1+r) 11 Future value/(1+required return)^number of years 12.50/(1+r)^2 12.50/10 1.25 1.25^(1/2) 1.118033989 1.118033989-1 0.118033989 11.80% Answer B 11 11 Cost of equity capital 11 11