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Hi John
Can you please help me solve and understand the logic of this question?
An all-equity financed company distributes 25% of its earnings each year and reinvests the balance.
The return on its projects is a constant 15% per annum.
Market capitalisation is estimated at $15,000,000 and Earnings are $125,000How do you calculate the rate of return required for the ordinary shareholder?
Thank you.
You use Gordon’s growth approximation to calculate the dividend growth rate of 11.25%
Given that we know the market value, we know the growth rate, and we know the current dividend (25% x 125,000), we then use the Growth Model formula (backwards)in order to calculate re (the shareholders required rate of return and the cost of equity).All of this is explained in detail in my free lectures for both Paper AFM and Paper FM.
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