Cost of Common Equity

CFA Level I
#1

Ajax Corporation’s common shares are trading with a current dividend yield of 3%. The secular growth rate of Ajax’s dividends is expected to be 6% annually. What is Ajax’s implied cost of common equity capital? a. 6.00% b. 9.00% b. 9.18% d. 9.54% A bit challenging.

#2

3% + 6% = 9% edit: actually, expected dividend will be 6% higher so 3.18 + 6% = 9.18%

#3

b

#4

Well, it must be C, 9.18:)

#5

D/P=0.03=>D/(D*1.06/(Ke-0.06))=0.03

#6

ahhh jeez i keep making stupid mistakes! obvy the div to use is next periods and i didnt even factor that in!

#7

i get the feeling i’m wrong anyway because it won’t be a 6% growth in dividend yield but a 6% growth in dividend :-F

#8

which study session are these questions coming from? I have no clue what dividend yield means.

#9

D/P = dividend yield

#10

pepp Wrote: ------------------------------------------------------- > which study session are these questions coming > from? > I have no clue what dividend yield means. dividend yield is the dividend divided by the price of the stock usually you would use the coming dividend in this case they said current yield which means the last dividend paid out

#11

anyway, here is my final answer even with 6% growth, the dividend yield will remain at 3% (the only thing that will increase the dividend yield and not just the dividend is increasing the payout ratio) so its got to be 6% + 3% = 9% on second thought, i don’t even know what’s the answer?

#12

a. 6.00% b. 9.00% c. 9.18% d. 9.54% Correct numbering, now what’s your pick?

#13

C

#14

B) 9% The current yield uses the next dividend D1 Continuing map1’s algebra: D1/P0 = D1/(D1/(k-g)) the D1 on the right side cancels out so… D1/P0 = k-g or 0.03 = k - .06 k = 9%

#15

Except current yield is D0/P0, or annual cash inflow/current market price

#16

D0/P0 = 0.03, not D1/P0 = 0.03

#17

Answer should be C. If you assume the stock price right now is $100, then the last dividend is $3. Do= $3 D1= $3.18 P= $100 K= ? g= .06 100= (3.18)/(K-.06) Solving for K = 9.18%

#18

Answer is C. rlange’s solution is clever, but you can just get the right answer by simple algebra: P0 = D1/(K-g) p0= D0(1.06)/(K-g) D0(1.06) = P0 * (K-g), divide by P0 D0/P0 *(1.06) = K-g 0.03 * 1.06 = K - 0.06 K= 9.18%

#19

or even simpler… d(1 + g)/p + g = 3(1.06)/100 + .06= .0318 + .06 = .0918

#20

d1/p0 + G =9% dividend growth will not change the yield from time 0 to time 1. the divi yield will still stay 3%, correct? i think C is incorrect and answer should be 9%, B If you gave dividend in $$ terms then you could use the D1 by using a growth rate and using formula D1/P0 + G to get cost of eq.