Dividend
and Cost of Equity
Cost of equity can be
calculated from the dividend valuation model. We can calculate cost of equity from the share
price and dividend information.
Dividend
Valuation Model –No Growth (Constant Dividend)
Cost of equity is calculated by simply
dividing the dividend by market price of share.
Cost of Equity = Dividend
(per annum or annual Dividend)
Market Share Price
Share
price of a company is $ 30 and Dividend for the year is $ 4. The cost of equity
of the company can be calculated as under;
= 4/30
=13.33%
1. Dividend Valuation Model – Growth
Cost of equity for company with constant
growth in Dividend may be calculated by following formula,
Cost
of equity = [Do (1+g)/Po] + g -
Dividend is Growing
XYZ
Company Market share price is $ 12; a dividend of 60 Cent is paid this year. The
dividend growth is expected to remain 9%. XYZ cost of equity can be calculated
as under
|
Share
Price
|
$ 12
|
|
Dividend
|
60 Cent
|
|
Cost
of equity ={ [ .6 x (1.09)/ $ 12 ]+ .09 } x 100
|
14.45%
|
2. Capital Asset Pricing Model:
Cost of equity can be
calculated by capital asset pricing method .Capital asset pricing model takes
into account the relative risk of market.
Rf + β (Rm- Rf)
Rf= Risk Free Return
Rm= Market Return
Β =Risk Factor
Government bond offer 3 %
return while the stock exchange offer a return of 8%, beta factor is 1.2, then
cost of capital would be as under
= 3% + 1.2(8%-3%)
=3% + 1.2(5%)
=.03+.06
=.09
= 9%
