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On cost of equity- am having problem on how to calculate cost of equity as below

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › On cost of equity- am having problem on how to calculate cost of equity as below

  • This topic has 3 replies, 2 voices, and was last updated 11 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • March 19, 2014 at 3:46 pm #162665
    munthaliaunward
    Participant
    • Topics: 6
    • Replies: 2
    • ☆

    a)ARDA p/l is an all equity company with 15 million $1 ordinary shares in issue.Its ordinary shares currently stand at $2.75(2005).The dividend for this year has just been paid

    Financial Data EPS……. Dividend per share
    2001 – 14………….10
    2002 – 28…………12
    2003 – 34 ……… 15
    2004 – 45 ……… 18
    2005 – 58 — 22
    NB ;Book value of equity/share was $3.78 in 2005
    You are required to estimate the cost of equity capital using:
    i)Dividend growth model
    ii)Earnings retention model

    March 19, 2014 at 5:54 pm #162674
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54701
    • ☆☆☆☆☆

    In both cases you have to use the formula:

    Cost of equity = Ke = (Do (1 + g))/Po + g

    (The formula on the formula sheet for Po, but rearranged).

    Do is 22; Po is 275

    The difference between the two models is how we estimate g – the dividend growth rate per annum.

    For (i) we calculate the average growth p.a. in the past: (4th root of (22/10)) – 1

    For (ii) we use the formula from the formula sheet g = b x r

    Here there is no one correct answer – you could do several things.
    To calculate b (the retention rate) you could calculate the average retention rate, or (and I think more sensible here) the most recent retention rate ( (58-22)/22 )
    For r (the accounting rate of return) you have no choice but to use the latest year and it is 58/378.

    Hope that helps.

    (If you need more examples, then I work through more examples in my lectures)

    (I don’t know where you found this example, but one thing is rather odd – you would not normally expect the market value of a share to be lower than the book value on the balance sheet)

    March 20, 2014 at 1:59 pm #162740
    munthaliaunward
    Participant
    • Topics: 6
    • Replies: 2
    • ☆

    thank you very much your tips are important to me.

    March 20, 2014 at 4:10 pm #162746
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54701
    • ☆☆☆☆☆

    You are welcome 🙂

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