IAI Actuarial Core Principles · Business Finance · Cost of capital and evaluating investment projects
Sundaram Foods Ltd expects next year's dividend of Rs 6 per share. Dividends have grown at a steady 5% per annum and are expected to continue to do so. The current ex-dividend share price is Rs 100. Using the dividend growth model, what is the cost of equity?
The cost of equity is 11%. Under the dividend growth model it equals the expected next dividend divided by the current price, 6/100 = 6%, plus the growth rate of 5%. Since Rs 6 is already next year's dividend, it should not be grown again.
- A6.0%
- B5.0%
- C11.0%Correct
- D11.3%
- 10.0%
Explanation
The next dividend D1 is already Rs 6, so Ke = D1/P0 + g = 6/100 + 5% = 11%. The 11.3% option wrongly grows the dividend again (6 x 1.05 = 6.3) even though Rs 6 is already next year's dividend. 6% omits growth.
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