dividend yield or gordons modelthis model is used

Question

Dividend yield or Gordon's Model

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

1. Cost of equity - K_e
2. Cost of preference share capital (perpetual) - K_p
3. Cost of perpetual debentures - K_d

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

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

    R = K_e

Where:  d₀ = DPS

            R₀ = Current MPS

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

Therefore K_e= d₀(1+g)/P₀+g

b) Cost of perpetual preference share capital (K_p)

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

Consequently: d_p = Preference dividend per share

                        P_p = Market price of a preference share

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

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

Therefore K_d =Int/V_d(1-T)

Whereas: K_d = % cost of debt

               T   = Corporate tax rate

              V_d = Market value of a debenture