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Dear John,
Lirio Co, estimate of value if large project is undertaken =
$0·0595 x 1·12–1 + $0·0595 x 1·12–2 + $0·3100 x 1·12–3 + [$0·3100 x 1·07/(0·12 – 0·07)] x 1·12–3 = $5·04 per share or $403 million market capitalisationCan you please advise where I can find notes/lectures on the above calculation? Or can you brief me on why this formula reminds me of bond valuation and the yield to maturity calculation?
Thanks!
The value is simply the present value of the future dividends (0.0595 for two years and then 0.31 thereafter) discount at 12%.
I don’t know why the examiner writes the discount factors as 1.12^(-1) etc (which is the same as 1/1.12) instead of using the tables, but that makes no difference.
From the fourth year onwards, we use the normal dividend valuation formula, but because it starts in 4 years instead of in 1 year (which is 3 years later), we need to discount the answer for 3 years to get the PV ‘now’.
This is standard discounting and I can’t remember which lecture it is in (and it is in the FM (was F9) lectures as well in the lectures on the valuation of securities).
Thank you, sir! I can now liken it to example one of chapter 16 but instead of valuing the firm based on cash flows we are valuing based on dividends.
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