How is the cost of equity derived in relation to dividends?

The cost of equity is typically derived using the dividend discount model (DDM), which values a company's equity based on the present value of its expected future dividends. In this context, the perpetuity formula is particularly relevant because it can represent a scenario where dividends are expected to grow at a constant rate indefinitely.

When employing the perpetuity formula, the cost of equity can be calculated by taking the expected dividend in the next period, dividing it by the difference between the required rate of return and the growth rate of dividends. This method assumes a constant growth in dividends, which is a common assumption for established companies that consistently generate profits and distribute a portion back to shareholders.

The average dividend payout, fixed interest payments, and variable returns do not directly address the relationship between equity cost and dividends in the context of the DDM and perpetuity valuation. The other options touch on different financial concepts but do not encapsulate the specific methodology for deriving the cost of equity through a dividend-oriented perspective as effectively as the perpetuity formula does.