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If retention ratio (r) = 0.5 and WACC =5 and Cost of equity is =4 than
How is growth calculated?
Do we multiply retention ratio with WACC or multiply retention ratio with cost of equity only.
i.e g=r* wacc or g=r*cost of equity ?
The dividend growth rate is relevant either for calculating the cost of equity (if you are told the market value of the shares) or for calculating the market value of the shares (if you are told the cost of equity.
There are two ways of calculating the growth rate (depending on the information given in the question) – either using the past dividend growth rate (which is the more common way) or by using Gordon’s growth approximation which is rate of retention x rate of return on reinvestment. (If we are not told the rate of return on reinvestment then we use the cost of equity instead).
The WACC has nothing to do with it. The WACC is calculated using the cost of equity and the market value of equity (and obviously debt). The dividend growth rate is only relevant in calculating either the cost of equity or the market value of equity.
All of this is covered in detail in my free lectures – I cannot type out all the lectures here!
Dear Tutor,
All the cost of equity (chapter 7) examples are based on listed companies. How is cost of equity calculated in a company which is not listed?
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