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The finance director of AQR Co has heard that the market value of the company will increase if the weighted average cost of capital of the company is decreased. The company, which is listed on a stock exchange, has 100 million shares in issue and the current ex div ordinary share price is $2.50 per share. AQR Co also has in issue bonds with a book value of $60m and their current ex – interest market price is $104 per $100 bond. The current after-tax cost of debt of AQR Co is 7% and the tax rate is 30%.
The recent dividends per share of the company are as follows.
Year 20X0 20X1 20X2 20X3 20X4
Dividend per share (cents) 19.38 20.20 20.41 21.02 21.80The answer for finding cost of equity is
Geometric average growth rate = [(21.8 / 19.38)^(1/4)] – 1 = 0.0298 = 2.98% or 3%
Putting this into the dividend growth model gives ke = ((21.8 x 1.03)/250) + 0.03
= 0.09 + 0.03 = 0.12 = 12%But I am getting the answer; ke = ((21.8 x 1.03)/2.50) + 0.03
= 0.09 + 0.03 = 9%Why have they taken Po as 250 when it is 2.5 in the question?
Sorry to interrupt,
The 2.50 is denoted in $dollars and the dividend per share is denoted in cents.So either you calculate everything in cents or in dollars.
In cents,
((21.8×1.03)/250)+ 0.03=12%In dollars,
((0.218×1.03)/2.5)+0.03 = 0.1198 or 11.9%(i.e. 12%)
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