In: Finance
ABC Co. has the following dividend payment history for the last five years, with the most recent dividend being $1.10: $0.50, $0.60, $0.80, $1.00, $1.10.
Historical growth rate estimation
Dividend growth model
SML model
WACC calculation
NPV calculation
Should the firm go ahead with the project?
a). CAGR = [(latest dividend/last dividend)^(1/n)] -1
= [(1.10/0.50)^(1/4)] -1 = 21.79%
b). Growth rate y-o-y:
c). Average growth rate = sum of growth rates/4 = (20%+33.33%+25%+10%)/4 = 22.08%
d). Dividend growth rate = retention ratio*ROE
= 0.9*0.25 = 22.50%
e). Expected growth rate = (21.79%+22.08%+22.50%)/3 = 22.12%
Dividend growth model:
f). Cost of equity =(D0*(1+g)/P0) + g
where D0 = 1.10; g = 22.12%; P0 = 70
Cost of equity = (1.10*(1+22.12%)/70) + 22.12% = 24.04%
SML model:
g). Cost of equity (using CAPM) = risk-free rate + beta*(market return - risk-free rate)
= 5% + 2*(13.50%-5%) = 22.00%
WACC calculation:
h). Average cost of equity = (24.04%+22.00%)/2 = 23.02%
i). WACC = (debt ratio*cost of debt*(1-Tax rate)) + (equity ratio*cost of equity)
Since D/E = 1, so D/V = 0.5 and E/V = 0.5
WACC = (0.5*10%*(1-35%)) + (0.5*23.02%) = 14.76%
NPV calculation:
j). Project WACC = firm WACC + 5% = 14.76% + 5% = 19.76%
NPV = sum of discounted cash flows
= -1,000,000 + 300,000*(1-(1+19.76%)^-7)/19.76% = 88,509.72 (using PV of annuit formula)
The project can be accepted as it has a positive NPV.