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IAI Actuarial Core Principles · Business Finance · Capital structure and dividend policy

Sundaram Ltd's shares trade at Rs 200 ex-dividend. A dividend of Rs 12 per share has just been paid and dividends are expected to grow at a constant 5% a year indefinitely. Using the dividend growth model, what is the cost of equity?

The cost of equity is 11.3%. The next dividend is 12 x 1.05 = Rs 12.60, a yield of 6.3% on the Rs 200 price, and adding growth of 5% gives 11.3%. Using the current dividend instead of next year's gives 11.0%.

  1. A6.0%
  2. B11.0%
  3. C11.3%Correct
  4. D12.0%
  5. 10.0%

Explanation

Next dividend D1 = 12 x 1.05 = 12.60. Ke = D1/P0 + g = 12.60/200 + 5% = 6.3% + 5% = 11.3%. Using 12/200 + 5% gives 11.0%, which forgets to grow the dividend.

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