Comments

  1. avatar says

    Hi Prof Moffat,
    Thanks for the clarity in the answer which i can now see.
    I realise that the DGM formular was what i hadnt slotted in properly by including the growth rate of 4% hence the (*1.04) and also the ex div and cum div prices.
    Rgds
    A.G

  2. avatar says

    Thanks for this detailed work out of the answer to the question.I went ahead and saw a similar qn and approached it as i thought you would using the exmaple you just did on this video but found the examiner gives a different answer(June 2013 Qn 4 a)
    My thinking was :0-1-2-3yr Divident = 25 c n increase 4% with ke= 9 %
    so mv at year 3 = 25/(0.09-0.04)=500
    using the df of 3 discount to zero yr= 500*0.772=$3.86
    Total mv = 3.86 * (5000/0.5)=38.6 mll
    I however found some inconsistency by the examiner(in my thinking but i could be wrong myself) as seen below(copied)
    “””2·5/(0·09 – 0·04) = $50 million .The dividend valuation model value (the capital value of the dividends at year 0) will be:
    50/1·09^2= $42·1 million.The current present value of dividends to shareholders, using the existing 3% dividend growth rate:
    (1·6 x 1·03)/(0·09 – 0·03) = $27·5 million””””
    vs
    his/her approach in the question you dealt with here(seems inconsistent)
    “””2·5/(0·09 – 0·04) = $50 million .The dividend valuation model value (the capital value of the dividends at year 0) will be:
    50/1·09^2= $42·1 million.The current present value of dividends to shareholders, using the existing 3% dividend growth rate:
    (1·6 x 1·03)/(0·09 – 0·03) = $27·5 million””””

    In short i would appreciate what you consider the best approach for the question here(2013)
    Thanks and sorry for the long story

    • Avatar of johnmoffat says

      You can get the same answer in several ways.

      There are two problems in what you have done for the new market value.
      First, it is fine to calculate the MV at time 3 using the formula, but you have written 25/(0.09-0.04). However the dividend at time 3 is 25, and so you should have written 25(1.04)/(0.09-0.04). This gives 520.
      Secondly, the formula gives an ex div value – so 520 assumes that the dividend at time 3 has already been paid (so it ignores the dividend at time 3).
      However there is a dividend at time 3 so that needs bring in (and discounting to time 0) as well. You can either do this separately, or add it to the 520 and then discount for 3 years.

      So 520 + 25 = 545. If you discount this for 3 years at 9% you get $4.21 – the same as in the examiners answer.

  3. Avatar of Mahoysam says

    Hi Mr John – I was glad to find a recording on this question as I didn’t like it much when I came across it in my revision kit.

    Mr John, just one thing. I am not quite clear on the concept of perfect market and market efficiency types, not sure where can I read about this in the notes? and this seems very important and you have included it in your tips for 2013.. or should I search it and read about it?

    Thanks, Maha

    • Avatar of johnmoffat says

      Perfect market is the situation when we are ignoring the costs charged by dealers when we buy and sell shares, and also assuming that share prices react instantly to changes in expectations of dividends (in practice it may take time for share prices to react to new information).

      Market efficiency is dealt with on page 9 of the Course Notes.

      (Calculations can not be asked on either of these – if either is asked then they will only be a written part of a question)

  4. avatar says

    sir …… i have a confusion …. pls make me understand !!!!!!!!!!!!!! using Dividend Growth Model we do Do(1 + g) / ke – g right? i did EVERY single question with this approach . but in june 2013 GXG company , examiner didnt use this approach , he just took total dividends divided by ke – g ………. with 4% and 3% growth………. and then compared both , and the difference is Share holder wealth ………. but my first apprach gives me just $500 difference …. by 4% growth it is 25(1.04)/ 0.09 – 0.04 = $5.20 per share ………. and with 3% the price is 25(1.03)/ 0.09 -0.03 = $5.15 per share . number of shares 10,000 and the share holder wealth is 500 in total . sir, if i use this approach , would he deduct my marks ?????? plz urgent answer required ! thanx.

    • Avatar of johnmoffat says

      Yes, you would lose marks.

      The market value of a share is the present value of future dividends, discounted at the shareholders required rate of return. You can only use the formula if there is constant rate of growth starting immediately.
      In this question there is only constant growth (at 4%) starting in 2 years time and so we need to discount the answer from the formula to get a present vale ‘now’.

      Also, the difference between the two values is not the shareholder wealth – it is the increase in the shareholder wealth.

      (Unless you are making a comment related to the particular lecture on the page, please ask questions on the relevant ‘ask ACCA tutor’ forum. That way you will be more certain to get a reply)

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