[dn100]

A firm's stock is selling for $85. The dividend yield is 5%. A 7% growth rate is expected for the common stock. The firm's tax rate is 32%. What is the firm's cost of retained earnings?
a) 8.14%
b) 12%
c) 12.35%
d) Cannot be determined

I am thinking that it is d because the formula I have says you need the dividend at the end of the first year. Or do I use $4.25 (5%*85), I didn't think that you did since it doesn't say that it is the 1st yr dividend. Thanks!!

[ArcSine]

"Dividend yield" refers to the ratio of next period's expected dividend, to the current share price. In other words, the expected growth in the dividend over the coming period is already baked in, and so in using the constant-growth model to solve for the cost of equity k, it's just a simple

k = dividend yield + growth rate

It appears your text is trying to hammer home that careful nuance in the term "dividend yield", because if you erroneously thought it gave you today's dividend, and you first applied the growth rate thereto before using the constant-growth model to solve for k, you'd come up with an answer that agrees with another of the four choices.