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Hello Sir,
Mr Gable has just received a dividend of $1,000 on his shareholding in Gonwithy Windmills. The market value of the shares is $8,000 ex div. What is the (nominal) cost of the equity capital, if dividends are expected to rise because of inflation by 10% in years 1, 2 and 3, before levelling off at this year 3 amount?I just want to ask that in the solution cash outflow is taken as 8000 in year 0 and cash inflow in year 1, 2 and 3 is respectively 1100, 1210 and 1331
I don’t undesrstand as why cash outflow is taken as 8000 ??
Thanks in advance.The cost of equity = the shareholders required rate of return.
To find the shareholders required rate of return, we look at the existing shares and use the fact that the market value is the present value of future expected dividends.
We know the market value is $8000.
We know the expected future dividends are $1000 plus inflation of 10% a year.
So he is expecting 1000 + 10% = 1100 in 1 years time; 1100 + 10% = 1210 in 2 years time, etc.You should read chapters 15, 16 and 17 of the course notes and watch the lectures that go with them – it is all explained there in detail.
thank you so much Sir for giving refernce to the chapters and lectures actually I havenot yet reached there but this example was given in the bpp study text in the topic of inflation that is why i asked cz i had listened to the lecture for inflation topic but it was not there i will go through those referred chapters
Thank you once again 🙂
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