Page 512 - FM Integrated WorkBook STUDENT 2018-19

Chapter 21

Question 9

Earnings retention model

A company is just about to pay an ordinary dividend of 9 cents per share and
the current share price is $2.45.

The accounting rate of return on equity is 10% and the dividend payout ratio is
25% and both of these figures are expected to remain at this level for the
foreseeable future.

Calculate the cost of equity for the company.

g = b × r e

g = 0.75 × 0.1 = 0.075 or 7.5%

Ex div share price = $2.45 – $0.09 = $2.36

Ke = [D 0 (1 + g)/P 0] + g

Ke = [$0.09 × 1.075/$2.36] + 0.075 = 0.116 or 11.6%

Question 10

Cost of preference shares

Bishop Co has 100,000 18% preference shares in issue with a nominal value of
$0.50 each. The current ex div market value is $1.75.

Calculate the cost of the preference shares.

Kp = D/P 0

Kp = ($0.50 × 18%)/$1.75 = 0.051 or 5.1%

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