In: Finance
Facts
D0=$2.35
g=5%
P0=$44
Beta =0.87
Rf =3.6%
Rm=11%
Debt Proportion = 25%
Equity Proportion = 75%
Kd=5.8%
Tax rate = 30%
Answer
1. Calculation of Cost of Equity (Re) using DGM
D1=D0(1+g) = $2.35(1.05)=$2.4675
Re=D1/P0 +g =$2.4675/$44+0.05 =0.1061 or 10.61%
2. Calculation of Cost of Equity (Ke) using CAPM
Ke= Rf+Beta*(Rm-Rf)
=3.6+0.87*(11-3.6)
=10.04%
3. WACC using DGM
Source | Prportion | Cost |
Weighted Cost(Prop*Cost) |
Equity | 0.75 | 10.61 | 7.9575 |
Debt | 0.25 | 4.06(5.8*(1-0.3)) | 1.0150 |
WACC | 8.9725 |
4.WACC using CAPM
Source | Prportion | Cost |
Weighted Cost(Prop*Cost) |
Equity | 0.75 | 10.04 | 7.530 |
Debt | 0.25 | 4.06(5.8*(1-0.3)) | 1.015 |
WACC | 8.545 |
5. Comparision of DGM vs CAPM
DGM | CAPM | |
1.Ke | 10.61% | 10.04% |
2.WACC | 8.9725% | 8.545% |
3.Advantages | It is easy to calculate and understand( NPV of future cash flows) | Widely used by investor |
4.Disadvantages |
DGM can be used only for dividend paying stocks. This model does not account for investment risk. Considers dividend in constant ratio. |
Too many assumptions are involved. |