CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Meera Auto Ltd has a current market price of ₹150 per share and expects to pay a dividend of ₹9 at the end of year 1. Dividends are expected to grow at a constant 5% forever. Using the Gordon model, what is the cost of equity (Ke)?
The cost of equity is 11%. Under the Gordon model Ke equals the expected dividend yield plus the growth rate. The dividend yield is 9 divided by 150, which is 6%, and adding the 5% growth gives 11%.
- A11%Correct
- B6%
- C9%
- D14%
Explanation
Gordon: P0 = D1/(Ke − g), so Ke = D1/P0 + g = 9/150 + 0.05 = 0.06 + 0.05 = 11%. Check: 9/(0.11 − 0.05) = 9/0.06 = ₹150. The 6% option is wrong because it omits the growth rate g.
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