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A company has just paid a dividend of $0.23 per share.Shareholders are expecting the dividend to remain at $0.23 per share next year but to increase at an average rate of 3% per year thereafter.Shareholders required rate of return is 12%and the rate of corporation tax is 25%.What will be the market value per share(to the nearest)?
ans is $2.56 how???You use the dividend valuation formula.
The term on top of the equation ( Do(1+g)) actually represents the dividend in 1 years time. Usually it is current dividend plus growth, but here we know that next years dividend is 23c.
So the MV = 23 / (0.12 – 0.03)
(Most books write the formula as D1/(Re – g). The F9 examiner is a bit silly here, but it is a problem he asks quite often these days)
John, how come we don’t account for the dividend in year 2 on this one? Ie find the pv of dividend in year 1 then plus it to the mv based on year 2 (use dvm for dividend in year 2 and then divide by the 1 year annuity factor)?
Using D1 / (Re – g) is accounting for the dividend in 1 years time and all later dividends (it is assuming the dividend continues in perpetuity growing at 3%).
If you want, you can take the PV at 12% of the dividend in 1 years time (23c) which is 20.539. Then you can use the formula as normal (23 x 1.03) / (0.12 – 0.03) = 263.99
However, because it is one year later you need to discount the answer for 1 year at 12% which gives 235.74Then add the two together: 20.539 + 235.74 = 256c or $2.56 (same as before)
Either way is fine, but this way does take a little bit longer 🙂
problem being similar to corhig co june 2012 question , sorry for posting in aryan002’s thread but suppose in corhig we had 2 years i,e year 1 and 2 , and the dividend grows after year 2 , we will find the mv of share using DVM similar to what you did in this question ? https://www.accaglobal.com/content/dam/acca/global/PDF-students/acca/f9/exampapers/F9_2012_jun_q.pdf
Yes – the answer does it exactly the same way!
In this question the growth does not start until the third year. So you have to discount the first few years individually, then use the formula for the later years and discount back to now to get the present value.
The examiner was deliberately testing the fact that the market value is the present value of future dividends (and not simply a question of using a formula).
It is something that he has been doing quite often in recent years.
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