A stock pays a year one dividend of $1. The dividend is expected to increase by 10% per year forever. The current price of the stock is $40 per share.
1. What is the implied cost of capital?
2. Assume now that dividend growth is subject to uncertainty (but everything else is the same). Each year after the first, with probability 1/2 the dividend growth rate is 10% and with probability 1/2 there is no growth in the dividend, relative to the previous year. What is the implied cost of capital?