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Chaptter 17

Esttimatinng thee cost of equuity – tthe

diviidend valuaation mmodel (DVMM)

The cost of equityy finance too the comppany is thee return thaat the invesstors expect to
achievee on their sshares.

2.1 DVM with nno growth in dividennds

D
r e = –––
P 0

rₑ = shareholdders’ requirred return, expressedd as a deciimal

D = constant ddividend froom year 1 to infinity

Pₒ == ex div maarket price of a sharee (ex div = AFTER divvidend paid)

In eexam questtions pricess could bee quoted exx div or cumm div. Reaad the
queestion properly!

Ex-ddiv share pprice = Cumm-div sharre price – ddividend duue

The vaalue of r e ccalculated is equivaalent to k e (the cost of equity ffinance too the
compaany)

Quuestionn 1

DVMM no growwth

KLF Co has paaid a divideend of $0.225 per share for many years annd expects to
conttinue payinng out at this level forr the foreseeeable futuure. The ccompany’s
curreent share pprice is $2..45.

Calcculate the ccost of equuity using thhe dividend valuationn model.

Ke == D/P 0

Ke == $0.25/$2.45 = 0.1022 or 10.2%%

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