ACCA Applied Skills · Financial Management · Models for the valuation of shares
Zeta Co expects free cash flow to equity (FCFE) of $2.40 million next year, growing at a constant 4% a year indefinitely. Its cost of equity is 12%. Zeta has 5 million shares in issue. What is the value per share using the dividend growth model applied to FCFE?
The value per share is $6.00. Equity value equals next year's FCFE of $2.40m divided by the cost of equity less growth (12% minus 4% = 8%), giving $30m, which is divided by 5 million shares.
- A$0.48
- B$0.60
- C$4.00
- D$6.00Correct
Explanation
Equity value = FCFE next year / (ke - g) = 2.40m / (0.12 - 0.04) = $30m. Dividing by 5 million shares gives $6.00. Option $4.00 results from using ke alone with growth ignored incorrectly (2.40/0.12 = 20m, /5m = $4.00), a wrong denominator.
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