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neilsolaris says

Hi. In the lecture, you said that the dividend growth formula is easy to prove. I’ve got a very elementary understanding of maths, having only done GCSE maths to C level about 25 years ago! But I’m curious, why do we minus the growth figure in the bottom line of the fraction? Thanks.

johnmoffat says

The only way to answer this is by giving you the proof (although I really think you should not waste your time on it!!!)

The MV is the present value of future dividends discounted at the shareholders required rate of return.

So: MV = Do(1+g)/(1+r) + Do(1+g)^2/(1+r)^2 + Do(1+g)^3/(1+r)^3+…….and so on for ever

Multiply this by (1+g)/(1+r) which gives:

MV(1+g)/(1+r)= Do(1+g)^2/(1+r)^2 + Do(1+g)^3/(1+r)^3+…….and so on for ever

Subtract the last equation from the first equation:

MV – MV(1+g)/(1+r) = Do(1+g)/(1+r)

Multiply both sides by (1+r)

MV(1+r) – MV(1+g) = Do(1+g)

Multiply through the brackets by MV

MV + MVr – MV – MVg = Do(1+g)

MV (r-g) = Do(1+g)

Divide by (r-g)

MV = Do(1+g)/(r-g)

I bet you wish that you had not asked!!!!

neilsolaris says

Thanks for that! I’ll have a think about all that, and let you know when I can make head or tail of it! Don’t worry though, I won’t study this proof to the exclusion of the exam!

eadinnu says

Can’t stop laughing. The proof is for F10 to be introduced by ACCA

johnmoffat says

neilsolaris says

I was just thinking about your proof, and I’ve come to a realization! Would I be correct in saying that the (optional) growth figure in the top of the equation is merely there to calculate the dividend payable in one year’s time? Is it the growth figure in the bottom of the equation (the one you minus from the cost of capital) which is more relevant, and it is only this figure which incorporates growth into the equation? I probably haven’t explained myself very well, but am I on the right lines?

Question 4 from the June 2010 exam makes more sense to me now when I think of it this way.

johnmoffat says

Yes – sort of

hisaf says

Sir,

like as you said market value represents the pv of the futer cash inflow, after a year time we may loose a cash inflow and so the market value shall be lower than as to previous year, how does it give rise to it?

johnmoffat says

The market value is always the PV of future expected receipts. If in a years time the expected receipts are lower, then in a years time the market value will be lower.

massivecodedake says

The nominal value of one unit of debenture is $100 .If the company has in issue $1000 6%debentures.Is it correct to say that the company has issued 10 debentures? The question “what will be the value of the debt “,does it mean the price of one unit of debenture?

johnmoffat says

The nominal value of one unit is usually $100, but it doesn’t have to be (it could for example, be $1000). In the exam, he does usually tell you the nominal value and it is usually $100. (If he doesn’t tell you, then assume it to be $100).

The reason I mention this is that to only have in issue $1000 in total would be unusual. If you are quoting from a question then check you have read it correctly and that it wasn’t just telling you that the nominal value of each unit was $1000.

If you are asked for the market value of the debt, then I would always calculate the value of one unit, but I would also (to be safe) show the total market value of all the units as well. (That only takes a second to multiply by the total number of units)

massivecodedake says

Thanks!

eadinnu says

Dear prof,

In example 5, you stated the MV cum div as 2.84 + 0.30= 3.14.

Since dividends are growing at the rate of 4 % p.a, in one year, the dividend to be received should be 0.30 *1.04 = 0.31.

If my assumption is correct, MV cum div should be 2.84 + 0.31 = 3.15 dollars.

Kindly throw more light if I am not correct.

Regards,

Ebele.

johnmoffat says

The current dividend is 0.30.

Ex div is the situation when the current dividend has just been paid. Cum div is when the current dividend is about to be paid.

eadinnu says

Thanks a lot. We cannot thank you enough.

acnca says

My Qn is on past exam paper dec 2007 Qn 1b(i).Using the approach that you used on this video lecture i would not agree with answer given by examiner(Market value of each convertible bond = (9 x 4·100) + (122 x 0·713) = $123·89)

This is wrong because the nominal value is not 9% but 100

I am right to calculate it:

100*4.1=410

100*0.713=71.3

market value gives 410+71.3=481.3 compared to 121.98

johnmoffat says

The answer is correct.

The market value is the present value of the future receipts.

The receipts are the interest each year (9% of nominal value = $9) and the redemption (122).

usman123usi says

Hi john ,

can you please tell what if the dividend growth rate is abnormal in the early years and then after it becomes with a constant rate of growth , how to calculate the ex.div price in this case .

thanks

johnmoffat says

The market value is the present value of the future expected dividends discounted at the shareholders required rate of return.

So for the years where the dividend is ‘abnormal’, these dividends will have to be discounted individually. Once is becomes a constant rate of grown you can use the dividend growth formula, but since the constant growth starts ‘late’ (lets say it starts in 3 years time instead of in 1 years time) you then have to discount the answer by the extra years (in this case an extra 2 years).

(Although you could be required to do this, it is much less likely – simply because shareholders are usually unlikely to expect precise future dividends – they are more likely to be expecting average growth – be it 1% a year or 10% a year or whatever, in which case we do not have the problem above.)

usman123usi says

Dear John ,

Thank you very much for your concern .its all crystal clear now .cheers.

johnmoffat says

You are welcome

sam420 says

Dear Jhon,

Two companies A and B have same default risk.

1) An investment (lending money) for one year to company A and a debenture for 10 year to company B, should the investor require higher rate of return from company B since investing in B means giving up opportunity to invest elsewhere after one year if a better opportunity arises. I do know debentures are traded but are not as liquid as 1 year loan.

2) Principal amount is returned without adjusting it for inflation. If debentures are not convertible or investors do not expect to profit from conversion from debt to ordinary stock, there is a massive difference between the actual value of principal amount. Suppose inflation is constant at 5% after one year when Company A returns the nominal principal of 100 it will value 95 but when the company B returns the principal it will value at 60. Are investors not supposed to require additional return i.e. market return +premium for the lost of value in currency.

3) With time default risk increases, even if year to year default risk between two companies are constant but with since company B is paying after 10 years it has more default risk, should investor not require higher return to compensate for this as well?

johnmoffat says

Remember one general thing – it is not one single investor who will determine the returns required, but investors in general. One single investor simply has to decide whether the return is good enough for him/her and therefore whether or not they are prepared to invest.

All of the factors you mention will have a bearing on the return that investors will require – certainly the time to repayment; certainly the riskiness of the companies (even though your A and B supposedly have the same default risk); certainly the general interest rates (which are likely to tie in to a degree with the expected rate of inflation).

(I am not sure why you say the debentures are not as liquid as a loan – an investor can sell the debentures on the stock exchange at any time they want, whereas with a one year loan they have no choice (they cannot get their money back sooner, nor can they (normally) extend the loan at the same interest rate).

kayez1234 says

Thanks so much OT, this is so clear. Happy for such a lecture as I am doing self study. Thanks a billion!!!

Saad Bin Aziz says

yup:-)

estherpang87 says

I heard it too..HAHA

admin says

asadraza says

did he really said that or its just my ears =D

4:20 (the examiner is a *****)

panayiotis2002 says

@asadraza, yes he said it

barzakh says

@panayiotis2002, damn i missed it i guess .. lol lack of concentration

rugalxx says

@asadraza, yes tht ws my quetion too hahahahah hilarious one hahhahaah cnt stop my self