Alpha Plc has just paid a dividend of $5.00 per share. The company plans to increase its dividend by 10 percent next year and will then reduce the dividend growth rate by 2 percentage points per year until it reaches the industry average of 4 percent, after which the company will keep that 4 percent constant growth rate, forever. Alpha Ltd is financed by a mix of 70% equity and 30% debt, with a cost of debt of 6%. Currently, risk-free assets, in the form of long-term government bonds, provide a return of 3%. The market in which Alpha Ltd operates provides an average return of 7% and Alpha’s Ltd’s level of systematic risk is 1.2. i. Determine an appropriate discount rate to be used in valuing the share price of Alpha Ltd. Explain your choice. ii. What is the share price of Alpha Ltd.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Alpha Plc has just paid a dividend of $5.00 per share. The company plans to increase its dividend by 10 percent next year and will then reduce the
Alpha Ltd is financed by a mix of 70% equity and 30% debt, with a cost of debt of 6%. Currently, risk-free assets, in the form of long-term government bonds, provide a return of 3%. The market in which Alpha Ltd operates provides an average return of 7% and Alpha’s Ltd’s level of systematic risk is 1.2.
i. Determine an appropriate discount rate to be used in valuing the share price of Alpha Ltd. Explain your choice.
ii. What is the share price of Alpha Ltd.
Step by step
Solved in 3 steps with 2 images
