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The question requires that we calculate the equity market value. The examiner finds the growth rate by comparing the two divident payouts and then uses the DGM. $5,729,760 (13,840,000 x 0,414) for the year to March 2015. Growth is 8,52% (5,729,760/5,280,000). Then he uses the growth to estimate the MV as follows:
(5,729,760 x 1,0852)/(0,125 – 0,0852) = $156,229,537 or $156,2 million.What I did was to use the formula g=b·r.
Divindend payout ratio is 0,414 so retention rate is 0,586. Cost of equity is 12,5%. Following that, g=0,586×0,125=0,7325 which is different from the 8,52 the examiners find. I calculate the MV in accoradane with the 0,7325 which gives a different result: 5729,76(1,0723)/(0,125-0,0723) which gives 111.709,48 (or 111.8 milion). Is my way correct? Because the difference in the results is big.Thank you for your time
You will know from my free lectures that shareholders determine the market value, and that they determine it based on the growth rate in dividends that they are expecting.
Also from my free lectures you will know that the growth rate ir r x b where r is the return on reinvestment. We only assume that this is equal to Re where there is no other information. Shareholders will not know what the cost of equity to the company is!
Having said this, you would still get credit for what you have done (since would be a Section C question in the current format of the exam).
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