Financial ManagementQuestion 5554 of 217
All Questions

7. The capital structure of KPS Limited includes 5,00,000 equity shares of ` 10 each. The market price of equity share (cum-dividend) is ` 75 per share. The company has declared to pay dividend on equity shares @ ` 6 per share which will be paid within next three days. The company has a history of consistent growth in its dividends. It has been predicted that in the next year KPS Limited will pay dividend on its equity shares@ ` 7.59 per share. The rate of dividend growth will be maintained in foreseeable future. The cost of equity is calculated as:

Options

A36.5%
B34.5%
C37.5%
D38.5%
For any discrepancies in this question, email contact@cadada.in

Correct Answer

Option C37.5%

All Options:

  • A36.5%
  • B34.5%
  • C37.5%
  • D38.5%

Ad

Detailed Solution & Explanation

Correct Answer: Option **C** Explanation: The cost of equity (Ke\displaystyle K_e) can be calculated using the Dividend Growth Model (Gordon's Growth Model):
Ke=fracD1P0+gK_e = \\frac{D_1}{P_0} + g
Where:
* D1\displaystyle D_1 = Expected dividend for next year = 7.59\displaystyle ` 7.59 per share
* P0\displaystyle P_0 = Ex-dividend market price per share
* g\displaystyle g = Constant dividend growth rate
**1. Calculate Ex-Dividend Market Price (P0\displaystyle P_0):**
The market price is given as cum-dividend (which includes the declared dividend of 6\displaystyle ` 6 to be paid within 3 days). To find the ex-dividend market price, we subtract the dividend from the cum-dividend price:
P0=textCumDividendMarketPricetextCurrentDividenddeclaredP_0 = \\text{Cum-Dividend Market Price} - \\text{Current Dividend declared}
P0=756=69textpershareP_0 = 75 - 6 = ` 69\\text{ per share}
**2. Calculate Growth Rate (g\displaystyle g):**
The current dividend is D0=6\displaystyle D_0 = ` 6 per share. The expected dividend next year is D1=7.59\displaystyle D_1 = ` 7.59 per share. Since D1=D0times(1+g)\displaystyle D_1 = D_0 \\times (1 + g), we have:
7.59=6times(1+g)7.59 = 6 \\times (1 + g)
1+g=frac7.596=1.2651 + g = \\frac{7.59}{6} = 1.265
g=0.265textor26.5g = 0.265\\text{ or } 26.5\\%
**3. Calculate Cost of Equity (Ke\displaystyle K_e):**
Substitute the values into the formula:
Ke=frac7.5969+0.265K_e = \\frac{7.59}{69} + 0.265
Ke=0.11+0.265=0.375textor37.5K_e = 0.11 + 0.265 = 0.375\\text{ or } 37.5\\%
Hence, **Option C** is the correct answer.

More Questions from Financial Management

Ready to Master Financial Management?

Practice all 217 questions with instant feedback, earn XP, track your streaks, and ace your CA Foundation exam.

Start Practicing — It's Free