Aashi (B.COM(H) & CA-Final) (140 Points)08 March 2014
formula is P =D1/ke-G
since retained earnings=45% =Rs 5 per share
so if retained earnings is 45% so earnings is 100% so earnings =Rs 11.11
divident = earnings-retained=11.11-5=6.11
since we need divident at the end of first year we multiply it with growth=6.11*(1.15)=7.03
so 88.89=7.03/ke - .15
by solving we get Ke-.15=.079:
Ke=.229:since % it is 22.90%
pls reply whether the answer is correct
Do(1+g)/ke-g) this formula is used when Do is given in the question but in this question, suggested answers assuemd that D1 is given hence no need of multiplication by 1.15. reamins will be same.
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A straight bond is the most basic of debt investments. It is also knows as a plain vanilla bond because there are no additional features that other bonds might have. For example, some bonds can be converted into shares of common stock. As with all bonds there is default risk, which is the risk that the company could go bankrupt and no longer honor its debt obligations.
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Yes dear it will wrong bcz... i think u have not interpreted question correctly. the question are as below
....Market price of share as on today is= 88.89(11.11*8)
if market price is given for today then y u are taking dividend of next comming year. u have to take it for dividend for today ..i.e dividend paid itself. i.e. Rs. 6.11.
The Question not demanding for price of next year. if it so then Do(1+g) is reuired to be done.
hence the ke= 21.87 will be answers.
hello Mr Saroj,i think the interpretation given by you is not appropriate as the price of share today(Po) is the excepted income the share gives in the future and discount it in the rate expected by share holder.so the income of the future is D1 and we are discountig it with the rate expected by share holder after adjusting the growth.in the question it is given that company retains 45% of its earnings,ie the total earnings earned during the year.so to find D1 we have to multiply with the growth
Take a second veiw As follow We require to calculate cost of capital which ofcourse will be the next year receivable for any share holder i.e will be equal to Current year earning percentage along with groth. if will earining 6.11 today how much in % = 6.11/88.89 = .06874 add into grouth which is expacted= .06874+ .15 =0.2187*100= 21.87 %
if we write in formula term it will be like
= current earning/Market price +Groth
= D0/MP + G
= 6.11/88.89 + .15
= 21.87 %
Replied 10 March 2014
I read somwhere that Cost of equity is 1/PE ratio.Is it correct and if so the answer would be 12.5.Correct me if i am wrong.
(B.COM(H) & CA-Final)
Replied 10 March 2014
Replied 10 March 2014
hai mr saroj ,I will not agree with your view because Ke is the rate expected by the shareholder.why we are deducting Ke-g because we assume that the earnings will grow by growth % so it will be difficult to calculate the futre earnings as share has perpetual life rather than bonds which has definite life.so we take the net effect
Mam, it is not correct concept to take the current year divident and calculate.the question is in dilemma we can write our assumption and solve i also refered books of A.N Sridhar in that book also sayme approach of taking d1 is done.
it is in topic of earnings capitalisation method of valutaion we assume that the rate earned by company it self is the rate expected by share holder if there is absense of information and that method it also ignors growth aspect since it is valuation of busineess now.so inthis cas we cannot take inverse of p/e ratio since all informatin is available and there is growth
I have another perspective
if have to calculate ke= D0/MP + G
if we have to calculate P1= D0(1+G)/Ke-g --> hoewever as per question requirements and available information we have to used.
we are taking ke-g not to find out cost of capital but we taking the same for determining what was previous cost of capital. u r takig about this formulla -P1= D0(1+G)/Ke-g
Inetrprete this formula= D0(1+g)- = Next expacted dividend
Ke-g= Previous cost of capital
Combine both and inetrprete = we are finding that how the price moved on the previous cot of capital i.e. current market price.