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Hello Sir,
Hope you are fine!
Sir I am doubtful in this section c questions small part.
Question: GXG CO (KAPLAN EXAM KIT)
GXG Co could suspend dividends for 2 yrs, and then pay dividends of 25 cents per share from the end of the 3rd year, increasing dividends annually by 4% per year in subsequent years. Dividends in recent years have grown by 3% per year. ( total shares=10 million and total dividend = 2.5million)
Solution part:( in which im doubtful )
The capital value of shares at the end of second year is calculated as= ( 2.5/(0.09-0.04)=50million
But sir in the calculation of capital value at the end of second year,the growth of 4 % is not included. Meaning 2.5(1.04)/(0.09-0.04).
Please clarify sir why the growth is not included in this question 49 june13 of Kaplan exam kit.I only have the BPP Revision Kit. However I do have all the past exam questions, and this was an exam question.
In the formula, the symbols in numerator Do(1+g) are that Do is the dividend that has just been paid at time 0, and Do(1+g) is therefore the dividend in 1 years time (at time 1). And usually the formula gives Po, the market value at time 0.
In this question, the first dividend we are given is the dividend at time 3. So if you treat this as being Do(1+g) then if we use the formula then this is the dividend at time 3 instead of at time 1, which is 2 years later. Therefore the answer given by the formula will be the value 2 years later as well, at time 2 instead of at time 2, and therefore needs discounting for 2 years.
This kind of problem is common in the exam and I do spent time explaining it in my free lectures.
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