CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Kaveri Foods Ltd has an equity share currently priced at ₹200. It expects a dividend of ₹12 per share next year, and dividends are expected to grow at a constant 6% per year. What is the cost of equity under the dividend growth model?
The cost of equity is 12%. Using the dividend growth model, the expected dividend yield is 12/200 = 6%, and adding the constant growth rate of 6% gives 12%. Working back, 12 divided by (12% minus 6%) returns the price of ₹200.
- A6%
- B12%
- C14%Correct
- D18%
Explanation
Ke = D1/P0 + g = 12/200 + 0.06 = 0.06 + 0.06 = 12%. Check: 12/(0.12-0.06)=200, which matches the price. Adding wrongly gives other values, e.g. 12% is not correct unless... recomputing: 12/200 = 6%, plus 6% = 12%.
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