Growth rate in stock dividends and the cost of equity) In March of this past year, Manchester Electric (an electrical supply company operating throughout the southeastern United States and a publicly held company) was evaluating the cost of equity capital for the firm. The firm’s shares are selling for $45.00; it expects to pay an annual cash dividend of $4.50 a share next year, and the firm’s investors anticipate an annual rate of return of 18 percent.
a. If the firm is expected to provide a constant annual rate of growth in dividends, what rate of growth must the firm experience?
b. If the risk-free rate of interest is 3 percent and the market risk premium is 6 percent, what must the firm’s beta be to warrant an 18 percent expected rate of return on the firm’s stock?
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