ExpertHard2 marksMultiple Choice
ACCA · Question 21 · Estimating the Cost of Capital
Section B - Case 2: Helios Co
Helios Co operates wind farms across Europe. It is looking to acquire a smaller competitor, Aura Ltd. To assess the acquisition, Helios needs to calculate its own Weighted Average Cost of Capital (WACC) and value Aura Ltd.
Helios Co Data:
Current share price: $4.50
Recent dividend paid (D0): $0.30
Historical dividends:
4 years ago: $0.24
3 years ago: $0.25
2 years ago: $0.27
1 year ago: $0.28
Using the historical dividend growth rate, what is Helios Co's estimated Cost of Equity (Ke) using the Dividend Valuation Model?
Section B - Case 2: Helios Co
Helios Co operates wind farms across Europe. It is looking to acquire a smaller competitor, Aura Ltd. To assess the acquisition, Helios needs to calculate its own Weighted Average Cost of Capital (WACC) and value Aura Ltd.
Helios Co Data:
Current share price: $4.50
Recent dividend paid (D0): $0.30
Historical dividends:
4 years ago: $0.24
3 years ago: $0.25
2 years ago: $0.27
1 year ago: $0.28
Using the historical dividend growth rate, what is Helios Co's estimated Cost of Equity (Ke) using the Dividend Valuation Model?
Answer options:
A.
11.8%
B.
12.4%
C.
12.8%
D.
10.5%
How to approach this question
First, calculate the historical growth rate 'g' using the formula: g = (Latest Dividend / Earliest Dividend)^(1/n) - 1, where n is the number of years of growth. Then apply the DVM formula: Ke = [D0(1+g) / P0] + g.
Full Answer
C.12.8%✓ Correct
1. Calculate historical growth rate (g):
g = (D0 / Dn)^(1/n) - 1
g = ($0.30 / $0.24)^(1/4) - 1
g = (1.25)^0.25 - 1 = 1.05737 - 1 = 5.74%
2. Calculate Cost of Equity (Ke):
Ke = [D0(1+g) / P0] + g
Ke = [$0.30(1.0574) / $4.50] + 0.0574
Ke = [$0.3172 / $4.50] + 0.0574
Ke = 0.0705 + 0.0574 = 0.1279 or 12.8%.
Common mistakes
Using n=5 instead of n=4 for the growth calculation. (There are 5 dividends, but only 4 periods of growth).
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