june 2013 q4… help

What we want to do here is to compare the current value of the company (while the proposed option is not yet implemented) with the value of the company once the proposed option is implemented. The problem here is that you cannot compare the current value of the company with the value in the future once the proposal has been implemented, we have to account for the time value for money. so what we do is that we get the value of the company after the option has been implemented and then we discount it back in order to be able to compare the current value with it.

In order to do that, it should be clear that the dividend we use in the growth model is basically the dividend for next year (since we add one to it). Therefore, the proposed dividend of 25c which is paid at the end of year 3 can be used to calculate the value of the company at year 2 and this will represent the value of the company after the policy or the proposal of the directors was implemented.

Now we need to compare that to the current value ( which is easily calculated using the formula), but as said, you cannot compare a value in the future to the current’s, you have to discount it, I saw the answer, they discounted it at the cost of capital to the power 2 as they are discounting the value for two years, you can also use the tables to get the DF (at 9%, 2 years) and you will get the same results.

Now you will be able to compare the two values and you can identify that the proposal will increase the SH wealth.

I hope that was clear enough, I am not a tutor and I am sure Mr John will be able to explain it better, plus, I hope Mr John will also be able to confirm that my understanding is correct, I am attempting F9 in December, so I also need more practice and study!

let’s wait for him! 🙂

Maha

Glad I could help 🙂

The 50M is simply the value of the company AFTER option one has been implemented. It is calculated using the growth model formula in the sheet. In order to calculate the value of the company after option one has been implemented, you have to calculate it using the new dividend proposed by the management which is 25c. Bearing in mind that this 25c is offered at the end of the third year, when we put the 25c in the formula ( without (1+g) because it is already the dividend of next year), it will give us the value of the company after two years NOT 3 years and therefore, to discount it to our current time, we will discount only two years not three years even though the dividend is offered by the end of the third year.

I know it is kind of confusing, I hope that was clear. BTW I got this concept clear by watching a revision lecture which has a similar problem, “i think, not sure” it was called QSX in the revision lectures section.

I am sure you know this already but I just want to make it clear that we don’t discount in EVERY valuation question, we only discount if we are offered values in the future such as the dividend and since we require the current dividend in the formula we discount it.

Hope that helped.

Maha