Z plc has in issue $1 shares with a market value of $2.80 per share. A dividend of 20c per share has just been paid (earnings per share were 32c). The company is able to invest so as to earn a return of 18% p.a.. Estimate the cost of equity?
Question
Z plc has in issue 2.80 per share. A dividend of 20c per share has just been paid (earnings per share were 32c). The company is able to invest so as to earn a return of 18% p.a..
Estimate the cost of equity?
Solution
To estimate the cost of equity for Z plc, we need to calculate the expected return on equity (ROE). The ROE can be determined by dividing the earnings per share (EPS) by the market value per share (MPS).
Given that the EPS is 32c and the MPS is $2.80, we can calculate the ROE as follows:
ROE = EPS / MPS = 32c / $2.80
To convert the EPS to dollars, we divide by 100: ROE = 0.32 / $2.80
Simplifying the calculation, we get: ROE = 0.1143
Next, we need to estimate the cost of equity using the formula:
Cost of Equity = ROE / (1 - Dividend Payout Ratio)
The dividend payout ratio is the proportion of earnings paid out as dividends. In this case, a dividend of 20c per share was paid, and the EPS was 32c. Therefore, the dividend payout ratio can be calculated as:
Dividend Payout Ratio = Dividend / EPS = 20c / 32c
Simplifying the calculation, we get: Dividend Payout Ratio = 0.625
Now, we can substitute the values into the formula to estimate the cost of equity:
Cost of Equity = 0.1143 / (1 - 0.625)
Simplifying the calculation, we get: Cost of Equity = 0.3048
Therefore, the estimated cost of equity for Z plc is approximately 30.48%.
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