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IAI Actuarial Core Principles · Business Finance · Capital structure and dividend policy

A firm pays a dividend of Rs 10 per share just paid, growing at 5% a year indefinitely. The ex-dividend share price is Rs 210. Using the dividend growth model, what is the cost of equity?

The cost of equity is next year's dividend divided by price plus growth. Next dividend is Rs 10.50, divided by Rs 210 is 5%, and adding 5% growth gives 10.0%.

  1. A9.8%
  2. B10.0%Correct
  3. C5.0%
  4. D9.5%
  5. 10.5%

Explanation

Next dividend = 10 x 1.05 = Rs 10.50. Cost of equity = 10.50/210 + 5% = 5% + 5% = 10.0%. Using 10/210 gives 4.76% + 5% = 9.8%, the error of omitting growth in the dividend.

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