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S. Bouchard and Company hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of equity from retained earnings change if the stock price changes as the CEO expects? Group of answer choices -1.49% -1.66% -1.84% -2.03% -2.23%

Answer :

PARRAINGO

Based on the change in the stock price, the change in the cost of equity to S. Bouchard and Company would be -1.84%.

How would the Cost of Equity change?

The original cost of equity is:

22 = (0.85 x 1.06) / (cost of equity - 6%)

Cost of equity + 6% = 0.901 / 22

Cost of equity = 0.901 / 22  + 6%

= 10.1%

The new cost of equity:

Cost of equity = (0.85 x 1.06) / 40 + 6%

= 8.25%

The change is:

= 8.25 - 10.1

= -1.84%

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