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An unlisted company is attempting to value its equity using the dividend valuationmodel.
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 tothe companybeing unlisted is 3%.
The calculationthat has been performedis as follows:
Equity value = $540,000 / (0.18 - 0.08) = $5,400,000
What is thefaultwith the calculation that has been performed?
Suggested Answer: C
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30 comments · newest first
MA
Martina
10 months ago
Really? $540,000 for dividends? That seems like a mistake.
VI
Vince
10 months ago
The dividend cash flow is fine, they just need to adjust the cost of equity.
ST
Steffanie
10 months ago
I agree, they messed up the cost of equity calculation.
MO
Mozell
11 months ago
Wait, how can they use a higher growth rate than earnings? Seems off.
EM
Emelda
11 months ago
The cost of equity should definitely be 12%, right?
ER
Erin
11 months ago
I recall that sometimes no adjustment is needed for the cost of equity, so option D could also be a possibility. But I'm not completely confident about that.
VE
Veronika
11 months ago
I think we covered something about growth rates in class, and if earnings growth is lower than dividend growth, it could be problematic. So, option C might be worth considering.
TA
Tammara
12 months ago
I'm not entirely sure, but I feel like the dividend cash flow used should definitely be the one that was just paid, which is $500,000. That makes me lean towards option B.
ZA
Zachary
12 months ago
I remember we discussed how the cost of equity should reflect the risk premium for unlisted companies, so I think option A might be correct.
AN
Antione
12 months ago
This looks straightforward enough. The cost of equity adjustment for being unlisted seems reasonable, so I'll focus on verifying the other inputs and the overall logic of the dividend valuation model.
PH
Phyliss
1 year ago
I'm a bit confused by the dividend cash flow used in the calculation. Shouldn't it be the $500,000 that was just paid, not $540,000? I'll need to revisit that part.
GA
Gail
1 year ago
Alright, I think I've got a handle on this. The key is properly adjusting the cost of equity for the company being unlisted. I'll work through that calculation carefully.
MA
Marylou
1 year ago
Okay, let me see here. The dividend growth rate seems higher than the earnings growth rate, so that's an immediate red flag. I'll need to double-check the assumptions.
BE
Benedict
1 year ago
Hmm, this looks like a tricky one. I'll need to carefully review the information provided and think through the dividend valuation model step-by-step.
DA
Danica
1 year ago
The dividend cash flow used should be $500,000, not $540,000. I guess they just pulled that extra $40,000 out of thin air.
KA
Kasandra
1 year ago
A straightforward mistake overall.
AN
Antonette
1 year ago
Definitely, it makes no sense.
MI
Mickie
1 year ago
Should stick to the actual dividend amount.
DE
Dewitt
1 year ago
Wow, this company must be really good at magic to make their dividends grow faster than their earnings! I wonder if they have a unicorn in the backyard or something.
EL
Elouise
1 year ago
User 1: The cost of equity used in the calculation should have been 12% (15% subtract 3%).
AD
Adelina
1 year ago
So, the correct answer is A) The cost of equity used in the calculation should have been 12% (15% subtract 3%).
MA
Mariann
1 year ago
Yes, but we need to adjust for the 3% risk premium due to the company being unlisted.
KR
Kristian
1 year ago
The dividend growth rate of 8% is way too high compared to the earnings growth rate of 6%. This is not sustainable in the long run.
GE
Gene
1 year ago
User 3: The cost of equity used in the calculation should have been 12%.
LA
Laurel
1 year ago
User 2: Yeah, that doesn't seem sustainable.
NO
Noah
1 year ago
User 1: The dividend growth rate is too high compared to earnings growth.
CI
Ciara
1 year ago
The cost of equity should be 12%, not 15%. The 3% risk premium for being unlisted should be subtracted from the proxy company's cost of equity.
CA
Carman
1 year ago
But isn't the cost of equity of the proxy listed company 15%? So, shouldn't it be used in the calculation?
AD
Adelina
1 year ago
I agree with Mariann, the cost of equity should have been 12% instead of 15%.
MA
Mariann
1 year ago
I think the fault is with the cost of equity used in the calculation.