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

Which of the following is the main assumption of the dividend valuation model when used to estimate the cost of equity?

The dividend valuation model assumes the market price of a share equals the present value of its expected future dividends, discounted at the shareholders' required return. It does not assume zero debt or that equity and debt returns are equal.

  1. AThe share price equals the present value of expected future dividendsCorrect
  2. BDividends are always paid out of profits after tax and interest only
  3. CShareholders require the same return as lenders
  4. DThe company has no debt in its capital structure

Explanation

The model values a share as the present value of its future dividends, discounted at the shareholders' required return. The model does not require the company to be debt-free, nor that equity and debt returns are equal; equity holders require a higher return because of greater risk.

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