CMA Study Group

Stock Valuation

  • 1.  Stock Valuation

    Posted 08-02-2021 05:16 PM
    Hi All,

    I am finding it very difficult to grasp the concept as to when we should use Next Dividend and when to use Dividend only in a question. I tried 10 questions and all answers were wrong due to this confusion. Like in the question below, how to identify that we are supposed to use Next Dividend or only Dividend in the formula.

    Question: 7By using the dividend growth model, estimate the cost of equity capital for a firm with a stock price of $30.00, an estimated dividend at the end of the first year of $3.00 per share, and an expected growth rate of 10%.


  • 2.  RE: Stock Valuation

    Posted 08-03-2021 04:32 AM
    Hello Muhammad,

    the question is asking about COST OF EQUITY/ COST OF RETAINED EARNINGS ( Both same)

    COST OF EQUITY = (Next Year Dividend/ Stock Price) + Growth rate
                                    = (3/30) + 10%
                                    = 10% + 10%
                                    = 20%

    If the questions says current year dividend is $3 and growth 10%. then we should consider 3 + 0.3= $3.3. Basically always consider next year dividend. Sometimes they already give next year dividend and to confuse they would give expected growth rate.

    Stock valuation formula is

    Stock price = (Next Year Dividend) / ( Cost of equity minus Growth rate).

    So if you see Cost of equity and Stock Valuation formula are related. Just that Cost of equity and Stock price change places.

    Let me know for further questions or clarifications.

    Thanks,
    Kiran


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    Kiran Kulkarni
    Director/Manager
    BENGALURU
    India
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  • 3.  RE: Stock Valuation

    Posted 08-03-2021 06:44 AM

    Question: 7

    By using the dividend growth model, estimate the cost of equity capital for a firm with a stock price of $30.00, an estimated dividend at the end of the first year of $3.00 per share, and an expected growth rate of 10%.

    A.

    21.1%

    B.

    11.0%

    C.

    12.2%

    D.

    20.0%

    ​Hello Muhammad Usman Cheema ,

    R = (D1/P)+G
    D1 is the next dividend. (dividend after a year). the problem says that estimated dividend at the end of the first year $3) this means after full year or after a year. look at the key word (ESTIMATED). so R = (3/30)+10% = 20%. the correct answer is choice D


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    Mohamed Aly
    Chief Financial Officer
    Jeddah
    Saudi Arabia
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