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Part B:
Using dividend valuation model to calculate upper range for likely issue prices the model answer uses g=br equation and puts 100-25/100*0.0968.
I know where 9.68% comers from but I can’t figure out where he gets 100-25/100 figures from for b. Could you help sir please. Thank youFrom the question, the EPS is 100 and the dividend per share is 25.
Therefore the retention is 100 – 25 = 75, and the retention rate = 75/100 = 75%.
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Sir John, in the Growth model and the dividend valuation model, i’m confused as to the r value.
1.Is it the cost of equity which we also calculated in the steps previously to find WACC? (i think my next answer covers it?)
2. If yes, then why didn’t we use growth model to find r and use this r in WACC? (i reframed my question below better )
I really hope you answer this as it is very troubling for me.
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I found this in ACCA website:
When an investment and the market is in equilibrium, prices should have been adjusted and should have settled down so that the return predicted by CAPM is the same as the return that is measured by the dividend growth model.
1. So what is wrong with calculating cost of equity using the growth model instead of CAPM and using THAT value to find WACC? (albeit it would differ significantly).
2. In the second requirement which asks to find maximum share price to be offered, why not use CAMP cost of equity in the growth model instead of the cost of equity found using Gordon’s growth approximation?
The cost of equity is always used in the calculation of the WACC.
Depending on the information given in the question, the cost of equity can be calculated using either CAPM (on the basis that it is the risk of the share that determines the required return by shareholders) or using the dividend valuation model (on the basis that it is the shareholders required return that determines the market value of the equity, and so we are just calculation it ‘backwards’).
In theory both approaches would give the same answer, but CAMP is regarded as being the better approach.
But in most exam questions you have no choice because the information given is only enough to do it one way.As far as the dividend growth is concerned, if using rb growth then r is the rate of return on re-investment.
All of the above is explained (with examples) in my lectures for both P4 and F9 (because this is all revision of F9).
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