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ACCA Applied Skills · Financial Management · Estimating the cost of capital

Kestrel Co has just paid a dividend of $0.40 per share. Dividends have grown at a constant 5% a year and are expected to continue to do so. The ex-dividend share price is $5.25. Using the dividend valuation model with constant growth, what is Kestrel's cost of equity?

The cost of equity is 13.0%. Next year's dividend is $0.42 (0.40 x 1.05), which divided by the $5.25 price gives 8%, and adding the 5% growth rate gives 13%.

  1. A12.6%
  2. B12.0%Correct
  3. C13.0%
  4. D7.6%

Explanation

Ke = D0(1+g)/P0 + g. D1 = 0.40 x 1.05 = 0.42. 0.42/5.25 = 0.08, so Ke = 8% + 5% = 13%. Wait check: 0.42/5.25 = 0.08 exactly, giving 13%. Therefore the correct figure is 13.0%, and 12.0% is wrong.

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