# Cost of Capital of Hero Honda

Topics: Time value of money, P/E ratio, Dividend Pages: 4 (657 words) Published: February 25, 2011
COST OF CAPITAL of HERO HONDA (WACC)

Component| Amount| Cost| Weight| Weighted Cost|
No debt: the amount given in bl sheet is a deferred sales tax|  |  |  |  | Equity| 39.94| 20.68206| 0.011526629| 0.238394441|
Retained earnings| 3425.08| 20.68206| 0.988473371| 20.44366632|  |  |  |  |  |
Total Capital employed| 41209.34|  |  | 20.68206076|

THE GORDON GROWTH MODEL
The Gordon growth model, developed by Gordon and Shapiro, assumes that dividends grow indefinitely at a constant rate.

Here,Vo = Value of the share
r = Required rate of Return
g = Dividend growth rate

For our calculation we have taken,
* Required Rate of return as Cost of Capital
* Dividend growth rate as CAGR of last 8 yrs dividend rate * CAGR of Dividend (last 8 yrs) = 20.49
* Last dividend distributed = 110

Valuation as per Gordon’s Model = 1015.385

1015.385 < 1718.98 (Current Market Price)

Hence, OVERPRICED

TWO STAGE DIVIDEND DISCOUNT MODELS

As it can be seen from the graph above there has been a sudden jump in the DPS of the company in the year 2010. So the Gordan’s model may not give the correct value of the share. To take care of this change we have used Twostage Dividend Model. Here we have divided the future dividend growth in two stages as: Growth Stage and Maturity Stage.

Formula for Two Stage Model:

Following are the assumptions taken by us:

* We have considered (t-1) i.e. 2009 as our base year rather than 2010. * Keeping in mind the increase competition from Small Car segments and increasing purchasing power of consumers we do not think the Growth Stage will sustain more than 5 years. * After that in Maturity stage we have considered the sector will be almost equal to the GDP growth. * For Required Rate of Return , we have considered Govt of India 10 yrs bond + Risk Premium High Growth Stage| 5 yrs|

Growth Rate| 20%|
GOI 10 yrs bond | 7.38%|
Risk...