ExpertMedium2 marksMultiple Choice
ACCA · Question 11 · Estimating the cost of capital
Section A
AstroTours PLC, a space-tourism company, has just paid a dividend of $0.40 per share. The current share price is $5.20. Historically, dividends have grown at a steady rate of 5% per annum, and this is expected to continue indefinitely.
Using the Dividend Valuation Model (DVM), what is AstroTours' estimated cost of equity?
Section A
AstroTours PLC, a space-tourism company, has just paid a dividend of $0.40 per share. The current share price is $5.20. Historically, dividends have grown at a steady rate of 5% per annum, and this is expected to continue indefinitely.
Using the Dividend Valuation Model (DVM), what is AstroTours' estimated cost of equity?
Answer options:
A.
12.7%
B.
13.1%
C.
8.1%
D.
15.0%
How to approach this question
Use the formula Ke = (D1 / P0) + g. Remember that D1 is the expected dividend next year, which is D0 * (1 + g).
Full Answer
B.13.1%✓ Correct
The formula for the cost of equity using the Dividend Valuation Model with growth is Ke = [D0(1+g) / P0] + g.
D0 = $0.40
g = 5% or 0.05
P0 = $5.20
D1 = 0.40 * 1.05 = $0.42
Ke = (0.42 / 5.20) + 0.05 = 0.08076 + 0.05 = 0.13076, or 13.1%.
Common mistakes
Using the dividend *just paid* (D0) in the numerator instead of the *expected* dividend (D1).
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