Problem 11.20 Underestimated Inc.’s common shares currently sell for $32 each. T
ID: 2789295 • Letter: P
Question
Problem 11.20 Underestimated Inc.’s common shares currently sell for $32 each. The firm’s management believes that its shares should really sell for $59 each. The firm just paid an annual dividend of $2 per share and management expects those dividends to increase by 9 percent per year forever (and this is common knowledge to the market). What is the current cost of common equity for the firm? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)
The current cost of common equity for the firm % ?
What does management believe is the correct cost of common equity for the firm? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)
Cost of common equity (as per firm's belief) %?
Explanation / Answer
Ke=D1/P0+g D1=2*109%=2.18 P0=32 g=9% P0=59 as per management Ke for the Firm Current cost of Equity 2.18/32+.09 15.81% Ke as per firm belief Current cost of Equity 2.18/59+.09 12.69%