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IAI Actuarial Core Principles · Business Finance · Key principles of finance

A share is expected to pay a dividend of ₹6 next year, growing at 5% a year indefinitely. Its current price is ₹100. Using the dividend growth model, what is the cost of equity?

The cost of equity is 11%. The dividend growth model adds the expected dividend yield, 6 divided by 100 or 6%, to the growth rate of 5%. Using only the yield gives 6%, and growing an already next-year dividend again gives 11.3%.

  1. A6.0%
  2. B5.0%
  3. C11.0%Correct
  4. D11.3%
  5. 1.0%

Explanation

Cost of equity = D1/P0 + g = 6/100 + 5% = 6% + 5% = 11%. The 11.3% figure arises from wrongly growing the dividend again (6.3/100 + 5%). 6% is the yield only.

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