Page 308 - FM Integrated WorkBook STUDENT 2018-19
P. 308
Chapter 17
Estimating the cost of equity – the
dividend valuation model (DVM)
The cost of equity finance to the company is the return that the investors expect to
achieve on their shares.
2.1 DVM with no growth in dividends
D
r e = –––
P 0
rₑ = shareholders’ required return, expressed as a decimal
D = constant dividend from year 1 to infinity
Pₒ = ex div market price of a share (ex div = AFTER dividend paid)
In exam questions prices could be quoted ex div or cum div. Read the
question properly!
Ex-div share price = Cum-div share price – dividend due
The value of r e calculated is equivalent to k e (the cost of equity finance to the
company)
Question 1
DVM no growth
KLF Co has paid a dividend of $0.25 per share for many years and expects to
continue paying out at this level for the foreseeable future. The company’s
current share price is $2.45.
Calculate the cost of equity using the dividend valuation model.
Ke = D/P 0
Ke = $0.25/$2.45 = 0.102 or 10.2%
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