Dividend yield or gordon''s model, Finance Basics

Dividend yield or Gordon's Model

This model is used to determine the cost of various capital components in particular:

  1. Cost of equity - Ke
  2. Cost of preference share capital (perpetual) - Kp
  3. Cost of perpetual debentures - Kd

a) Cost of equity (Ke)- This can be determined with respect to:

    Zero growth firm - P0 = d0      Therefore = d0/P0 

    R = Ke

Where:  d0 = DPS

            R0 = Current MPS

Constant growth firm - P0 = d0(1+g)/Keg

Therefore Ke= d0(1+g)/P0+g

b) Cost of perpetual preference share capital (Kp)

Recall, value of a preference share (FRS) =   Constant DPS/Kp

Consequently: dp = Preference dividend per share

                        Pp = Market price of a preference share

c) Cost of perpetual debenture (Kd) - Debentures pay interest charges, which an allowable expenses for tax purposes.

    Recall, Value of a debenture (Vd)=Interest charges p.a. in ∞/Cost of debt Kd

Therefore Kd =Int/Vd(1-T)

Whereas: Kd = % cost of debt

               T   = Corporate tax rate

              Vd = Market value of a debenture

Posted Date: 1/30/2013 4:24:55 AM | Location : United States

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