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Hi, sir
I have trouble understanding the solution about one of reasons why there may be a difference between the two share prices mentioned in Dec 2008 Q1 d. ” …The cost of equity of D company may not be exactly equal to 10%” But we really use 10% as the cost of equity in order to get the share price by the dividend growth model.It is shareholders who determine the share price by discounting the expected future dividends at their required rate of return (which is the same as the cost of equity). This is what the dividend valuation formula is doing, assuming they expect constant growth.
In practice you do not know what rate of growth they are expecting, and in practice you do not know what return the shareholders require. In the calculation part we used 10% because that was what was given in the question, but there is no way of knowing (in real life) exactly what rate of return they want. If it was actually 9% or 11% then the share price would be different.
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