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Chapter 17

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

b = 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%

Illustrations and further practice

Now try TYU questions 6 to 9 from Chapter 17.

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