Company trades at an EV/EBITDA of 8x, payout ratio of 75%, yield 9% and a ROE of 12%. What is cost of equity?
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So this is definitely pushing you toward using the cost of equity formula as follows: next year dividends/share / market price + growth rate of dividends. So dividend payout = dividend/net income, yield = dividend/share price, ROE=net income/equity. I started with dividend payout, which is 75 cents for every dollar, so NI = $1. Trifle is 9%, so 0.75/x=0.09. That gives you a price around 8.33. Then, with ROE we use that 1/Equity = 12%, so equity is about 8 in this situation. ROE isn't needed as best I can tell, but we have everything we need, knowing that dividend = 0.75 and price = 8.33, divide those two and add growth rate to get a baseline COE of 9% (assuming g of 0). I'm just spitballing here, so let me know if there's anything else to keep in mind.
Trifle should say yield. I’m typing on my phone so pardon the errors. Obviously g wouldn’t be zero, but that’s needed for the complete formula so add your g as needed.
Is it oversimplification to say that in these types of questions the cost of equity is simply yield plus dividend growth rate?
I’m a freshman so I just did it the long way but the calculations in this instance basically showed that. Technically COE should use forward yield but thats minutia.
It is to some extent, but it always works out to be yield + g when dividends are growing at a constant rate.
Using a slightly rearranged version of the Gordon model:
(0) Cost of Equity = D1/P0 + g
This only works if we assume constant growth, which is a necessary assumption given the information given.
(1) Dividend Yield = 9% = D1/P0
(2) Growth Rate = ROE*(1-Payout Rate)
Growth Rate = 12%*25% = 3%<p> </p>Now we can substitute (1) and (2) into (0):
Cost of Equity = 9% + 3% = 12%
Why is the growth rate = ROE*(1-payout rate)?
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