CA INTERMEDIATE: COSTING & FM · COST OF CAPITAL

Cost of equity: dividend growth (Gordon) model

Ke = D1 ÷ P0 + g, where D1 = D0 × (1 + g) is next year’s expected dividend.

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Worked examples

Example 1 · level 1

Reddy Cements is expected to pay a dividend of ₹4 per share next year. The share trades at ₹100 and dividends are expected to grow at 3% a year. Find the cost of equity (%).

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Dividend yield = 4 ÷ 100 × 100 = 4%.
Ke = 4% + 3% = 7%.

Answer: 7 %

Example 2 · level 2

Bansal Steels Ltd’s next dividend (D1) is expected to be ₹7, growing at 4% p.a. thereafter. Its share price is ₹175. Find Ke (%).

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Dividend yield = 7 ÷ 175 × 100 = 4%.
Ke = 4% + 4% = 8%.

Answer: 8 %

Example 3 · level 3

Patel Packaging has just paid a dividend (D0) of ₹10 per share. Dividends are expected to grow at 4% p.a. The current market price is ₹250. Find the cost of equity (%), two decimals.

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D1 = 10 × 1.04 = ₹10.4.
D1 ÷ P0 = 10.4 ÷ 250 = 4.16%.
Ke = 4.16% + 4% = 8.16%.

Answer: 8.16 %