Cost of long-term funds - part 2

In this lesson

1. 0:00 Understanding the cost of equity
2. 0:43 Dividend valuation model formula
3. 1:19 Why growth matters for ordinary shares
4. 2:29 Cost of equity with dividend growth
5. 3:30 Worked example calculation
6. 4:21 Connecting equity to weighted average cost

About this lesson

You'll explore two approaches: the basic dividend valuation model and the more practical dividend growth model, which accounts for the realistic assumption that ordinary share dividends grow over time. Through a worked example, you'll see how to apply the formula Ke = D1/P0 + g to find the cost of equity, then discover how this feeds into calculating your company's overall cost of capital. This concept is essential for FM, AFM, and SBL papers, where you'll regularly need to determine whether projects create value. The lesson begins by establishing that equity has a real cost—the dividend paid to shareholders—and explains why this matters in practice. You'll learn the difference between preference shares (which have fixed, non-growing dividends) and ordinary shares (which typically grow), and see why the basic formula Ke = D/P0 needs adjustment. The key insight is understanding what each component means: D1 is the dividend expected in a year's time, P0 is the ex-dividend share price, and g is the growth rate. You'll work through a realistic calculation where a company paying 30 cents per share with an 8% growth rate and a share price of £2.75 yields a cost of equity of 19.8%—demonstrating how small changes in assumptions can significantly affect your final answer.

Duration: 5m