FM – L2 – Q20 – Cost of capital

Calculate WACC using dividend growth model for cost of equity, given dividend, share price, and debt details.

Question

A company, Volta Ventures Ltd, has just paid an annual dividend of GH¢0.18. Investors expect the annual dividend to grow by 3% each year in perpetuity. The current share price is GH¢1.55, and the total market value of the company’s shares is GH¢1,200,000.

The company has debt capital on which the yield is 7.8% before tax. The rate of tax is 30%. The total value of the company’s debt is GH¢350,000.

Calculate the weighted average cost of capital. Use the dividend growth model to estimate the cost of equity.

Answer

Answer: Cost of equity = (18(1.03) / 155) + 0.03 = 0.1496 or 14.96%. WACC = [(350 / (1,200 + 350)) × 7.8(1 – 0.30)] + [(1,200 / (1,200 + 350)) × 14.96] = 1.23 + 11.58 = 12.81%.

Tags: Cost of Equity, Debt Capital, Dividend Growth Model, Financial management, WACC
Level: Level 2

Topic: Cost of capital

Uploader: Samuel Duah