An unlisted company is attempting to value its equity using the dividend valuation model.

CIMA F3 Question Answer

Relevant information is as follows:

• A dividend of $500,000 has just been paid.

• Dividend growth of 8% is expected for the foreseeable future.

• Earnings growth of 6% is expected for the foreseeable future.

• The cost of equity of a proxy listed company is 15%.

• The risk premium required due to the company being unlisted is 3%.

The calculation that has been performed is as follows:

Equity value = $540,000 / (0.18 - 0.08) = $5,400,000

What is the fault with the calculation that has been performed?

The cost of equity used in the calculation should have been 12% (15% subtract 3%).

The dividend cashflow used should have been $500,000 rather than $540,000.

The dividend growth rate is unsuitable given that earning growth is lower than dividend growth.

The cost of equity used in the calculation should have been 15%; no adjustment was necessary.

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