Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › DD co Specimen dec 16
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- September 18, 2018 at 11:53 pm #475167
I have a question in calculating growth. I have understood examiners answer that how he has calculated growth rate , but I just want to ask can’t we calculate growth in the following way , however, the answer is not coming correct, can you please tel me what mistake I am doing here?
We know that we can calculate growth by gordon’s retention model
g = retention ratio x return on equity
In this question payout ratio is given of 40% which implies that retention ratio is 60%
Now in question number of ordinary shares issued are 25m. And question says that current dividend per share of company is $0.5 per share. So in this way total dividends paid would be 25m x 0.5 = $12500000.
As we know that Dividend paid = PAT x payout ratio
so by using this formula we can calculate PAT= 12500000 / 0.4 = $31250000.Now we know Retained earnings or profit = PAT – dividend paid
so Retained earnings = 31250000 – 12500000 = $18750000Return on investment = PAT / [ordinary share capital + reserves]
Ret on inv = 31250000 / [60000000 + 18750000] = 0.4g= 0.6 x 0.4 = 0.24
September 19, 2018 at 7:06 am #475185The retention rate is indeed 60%.
However ‘r’ in the formula is the return on reinvestment (which is not the same as the return on equity). For this you would need to know the market value of the long-term capital, and we do not know this.
There is not enough information to use rb, and therefore we have to use past dividend growth as per the answer.
September 26, 2018 at 8:15 pm #475815Sir as you said that in rb , r is the return on investment which is not the same as return on equity. However in an Dec 2016 cbe sample MCQ they have asked the following quetion
Carp Co has announced that it will pay an annual dividend equal to 55% of earnings. Its earnings per share is $0.80, and it has ten million shares in issue. The return on equity of Carp Co is 20% and its current cum dividend share price is $4.60.
What is the cost of equity of Carp Co?
Here for “r” they have used return on equity of 20%
September 27, 2018 at 9:18 am #475850Yes they did use the return on equity, because there was no choice but to assume that the return on reinvestment was the same given that there was no other information.
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