CFA Practice Question

There are 201 practice questions for this study session.

CFA Practice Question

Joiner Industries has just paid a dividend of 1.65 a share and the market expects its dividend to continue to grow at a constant rate of 5.5% for the foreseeable future. The company wants to issue new shares to raise funds for an investment project. Based on its risk, investors require a 14% rate of return. Investment banking fees will amount to 4% of the sales proceeds. Joiner's cost of new equity is
A. 14.35%
B. 18%
C. 15.5%
Explanation: Under a constant growth model, kequity = Dividend yield + Capital gains yield
14 = Dividend yield + 5.5 => Dividend yield = 14 - 5.5 = 8.5%
knew equity = [Dividend yield / (1 - Flotation cost)] + Capital gains yield = [8.5 / (1 - 0.04)] + 5.5 = 14.35%

User Contributed Comments 11

User Comment
danlan2 (k%-5.5%)*(1-0.04)=14%-5.5%

so k=14.35%
HenryQ Is 5.5% capital gain yield or dividend yield?
jhmorris This problem can also be solved using the Gordon Growth model.

1. Find the value of the equity

1.65(1.055) / (0.14 - 0.055) = 20.47941176

2. Since issuance costs are 4% of value, reduce the value of the equity by that percentage.

20.47941176(0.96) = 19.66023529

3. Take the fee-adjusted value and plug it into the Gordon Growth model and solve for r.

19.66023529 = 1.74075 / (r - 0.055)

r = 0.143541667
pjdeschenes nice.
DZ2008 brilliant jhmorris, brilliant
Allen88 very nice jhmorris
omf24 Impressive jhmorris.
tim2 The calculation seems silly to me. Why is the answer not 14/(1-.04)? It says in the question investment banking fees will be 4% of the sales proceeds, not 4% of the proportion of the sales proceeds atributable to the value of the company arising form dividend yield rather than capital growth. Where on earth did they get that from?
charomano Ke = Dividend Yield + Capital gains yield = D/P + g

Gordon growth model => P = D/(k-g) => k = D/P + g
swt326 Thanks jhmorris, it's much better to derive an answer through an already known formula than memorizing another.
Allstats Nice question. Well done jhmorris
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