Answer:
Option (C) is correct.
Explanation:
Given that,
D0 = $0.85
P0 = $22.00
gL = 6.00% (constant)
Cost of common equity at P0 = $22.00:
[tex]=\frac{D0(1+gL)}{P0}+gL[/tex]
[tex]=\frac{0.85(1.06)}{22}+0.06[/tex]
[tex]=\frac{0.901}{22}+0.06[/tex]
= 10.09%
Cost of common equity at P0 = $40.00:
[tex]=\frac{D0(1+gL)}{P0}+gL[/tex]
[tex]=\frac{0.85(1.06)}{40}+0.06[/tex]
[tex]=\frac{0.901}{40}+0.06[/tex]
= 8.25%
Hence, it is clear from the above calculation that if the price of stock increases then as a result cost of equity decreases.
Here, [10.09% - 8.25] = 1.84%, cost of equity decreases by 1.84%.
