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The dividend is expected to grow at 3% for three years and 2% afterwardsCost of equity is 14%
Dividend 250I am having prob in the annuity to infinity factor part
The given solution is (1/ke-g)*pv at year 3
The annuity factor would be 8.333*0.675 = 5.624But I am used to this formula which is (factor year 1 to infinity) -(factor year 1-3)
Based on the table of PV @14%
Year 1 0.877
Year 2 0.769
Year 3 0.675So the annuity factor for year 4 to infinity is
8.333- 2.321 = 6.012Why there are such diff in annuity factor from the two ways of calculating the annuity factor for perpetuity?
You can do it either way, except that if you are doing it the way that you want to, then you need to subtract the annuity factor for 2 year (not for three years).
The perpetuity factor give you the PV if it is for years 1 to infinity. For 3 to infinity you need to subtract the annuity factor for 2 years.
The answer might be a little different but this is only because of rounding and this is not a problem in the exam.
Thanks mr John. Shouldn’t it be year 4 to infinity instead of year 3 to infinity since the dividend growth change at year 4?
No – 3 to infinity.
The dividend at time 3 will have grown at 3% per year for 3 years, but will then grow at 4% in the fourth year and each year indefinitely.
I am a little confused here. The question says the dividend is expected to grow at 3% for three years and then 2% afterwards.
So from y1-y3 dividend grows by 3% each year and 2% for Year4 onwards right? So year 4 onwards is perpetuity or otherwise.thus the perpetuity should starts at 4 years time right cos the dividend change at 2% in year 4 which is in perpetuity from year 4 onwards? I am so confused right now, please clarify please
Just suppose for a moment that the dividend was 10c at time 1 growing at 2% per year. Then the present value of the dividend from 1 to infinity would be given by multiplying by 1/r. This would give a value at time 0.
Suppose instead that there was a dividend of 10c at time 3 growing at 2% a year. Then since it starts 2 years later (time 3 instead of time 1) multiplying by 1/r gives a PV 2 years later as well – time 2 instead of time 0.
In this question, the dividend at time 3 will have inflated for 3 years, but from then on it will be growing at 2% each year.
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