The question is probably in your Revision Kit. If not, then search on Google typing the date of the exam, or the name of the question (it is still on the ACCA;s website, but they have just removed the link to it).

Then you would get the wrong answer and you would lose marks!!

We always need to use the dividend growth rate when calculating the market value – the market value is based on expected future dividends and if their is expected growth in dividends then the market value is affected.

I do suggest that you watch the free lectures on the valuation of securities.

Do(1+g) is calculating the dividend in 1 years time. We are first calculating the price in 3 years time using the formula, and the dividend 1 year later is therefore in 4 years time and is 70c – not 70c plus growth.

Mr Moffat, since this was might first time to come face to face with such type of exam question, my comment is that it was a real shocker!!

However, I salute you for breaking up the solution into understandable components in part a and b. However, in part c of your lecture you introduce Modi and Miller theory in Dividend policy of the company. You say that in theory dividend policy does not matter. Is because the WACC uses cost debt in the formulas? I cannt just get my head around this idea.

At one extreme they can pay out all of their profits as dividends – this will mean high dividends, but because they are not retaining and reinvesting the company will not grow, the dividends will not grow, and the share price will not grow (i.e. no capital growth).

On the other extreme, they can pay out a very low proportion of their profits as dividend – this will mean low dividend, but because of the reinvestment of the retained profits there will be high growth. (You will have seen a little numbers example of how this works in my lecture on share valuations)

M&M say that it is irrelevant to shareholders which policy the company follows. If the company chooses to pay low dividends and the shareholders want more cash, then they could always sell some shares.

The cost of debt is not relevant to MM’s dividend irrelevant theory. It is relevant to M&Ms theories on gearing – this is covered in Chapter 19 of our free Course Notes, and the free lecture that goes with it.

In this lecture for June 2010 Q4 QSX, our calculations identified three prices due to distortion of information. The share price in 2009 is $6.93 (Divi Growth model), actual $6.48 and $7.51 (discount of 70c dividend).

Before I continue, thank you very much for helping me identify 70c as my Div(1+g).

Lastly, kindly help me link the actual share price of $6.48 to semi strong market hypothesis.

There is no real need to link it (and neither does the examiners answer).

However I can’t really add much to what I say in the lecture at the end of part (b) – if the information about the proposed dividends was publicly available (i.e. strong-form efficiency) then the share price would in theory be higher. Since it is lower this is not the case.

Hi Prof Moffat, Thanks for the clarity in the answer which i can now see. I realise that the DGM formular was what i hadnt slotted in properly by including the growth rate of 4% hence the (*1.04) and also the ex div and cum div prices. Rgds A.G

Thanks for this detailed work out of the answer to the question.I went ahead and saw a similar qn and approached it as i thought you would using the exmaple you just did on this video but found the examiner gives a different answer(June 2013 Qn 4 a) My thinking was :0-1-2-3yr Divident = 25 c n increase 4% with ke= 9 % so mv at year 3 = 25/(0.09-0.04)=500 using the df of 3 discount to zero yr= 500*0.772=$3.86 Total mv = 3.86 * (5000/0.5)=38.6 mll I however found some inconsistency by the examiner(in my thinking but i could be wrong myself) as seen below(copied) “””2Â·5/(0Â·09 â€“ 0Â·04) = $50 million .The dividend valuation model value (the capital value of the dividends at year 0) will be: 50/1Â·09^2= $42Â·1 million.The current present value of dividends to shareholders, using the existing 3% dividend growth rate: (1Â·6 x 1Â·03)/(0Â·09 â€“ 0Â·03) = $27Â·5 million”””” vs his/her approach in the question you dealt with here(seems inconsistent) “””2Â·5/(0Â·09 â€“ 0Â·04) = $50 million .The dividend valuation model value (the capital value of the dividends at year 0) will be: 50/1Â·09^2= $42Â·1 million.The current present value of dividends to shareholders, using the existing 3% dividend growth rate: (1Â·6 x 1Â·03)/(0Â·09 â€“ 0Â·03) = $27Â·5 million””””

In short i would appreciate what you consider the best approach for the question here(2013) Thanks and sorry for the long story

There are two problems in what you have done for the new market value. First, it is fine to calculate the MV at time 3 using the formula, but you have written 25/(0.09-0.04). However the dividend at time 3 is 25, and so you should have written 25(1.04)/(0.09-0.04). This gives 520. Secondly, the formula gives an ex div value – so 520 assumes that the dividend at time 3 has already been paid (so it ignores the dividend at time 3). However there is a dividend at time 3 so that needs bring in (and discounting to time 0) as well. You can either do this separately, or add it to the 520 and then discount for 3 years.

So 520 + 25 = 545. If you discount this for 3 years at 9% you get $4.21 – the same as in the examiners answer.

Hi Mr John – I was glad to find a recording on this question as I didn’t like it much when I came across it in my revision kit.

Mr John, just one thing. I am not quite clear on the concept of perfect market and market efficiency types, not sure where can I read about this in the notes? and this seems very important and you have included it in your tips for 2013.. or should I search it and read about it?

Perfect market is the situation when we are ignoring the costs charged by dealers when we buy and sell shares, and also assuming that share prices react instantly to changes in expectations of dividends (in practice it may take time for share prices to react to new information).

Market efficiency is dealt with on page 9 of the Course Notes.

(Calculations can not be asked on either of these – if either is asked then they will only be a written part of a question)

sir …… i have a confusion …. pls make me understand !!!!!!!!!!!!!! using Dividend Growth Model we do Do(1 + g) / ke – g right? i did EVERY single question with this approach . but in june 2013 GXG company , examiner didnt use this approach , he just took total dividends divided by ke – g ………. with 4% and 3% growth………. and then compared both , and the difference is Share holder wealth ………. but my first apprach gives me just $500 difference …. by 4% growth it is 25(1.04)/ 0.09 – 0.04 = $5.20 per share ………. and with 3% the price is 25(1.03)/ 0.09 -0.03 = $5.15 per share . number of shares 10,000 and the share holder wealth is 500 in total . sir, if i use this approach , would he deduct my marks ?????? plz urgent answer required ! thanx.

The market value of a share is the present value of future dividends, discounted at the shareholders required rate of return. You can only use the formula if there is constant rate of growth starting immediately. In this question there is only constant growth (at 4%) starting in 2 years time and so we need to discount the answer from the formula to get a present vale ‘now’.

Also, the difference between the two values is not the shareholder wealth – it is the increase in the shareholder wealth.

(Unless you are making a comment related to the particular lecture on the page, please ask questions on the relevant ‘ask ACCA tutor’ forum. That way you will be more certain to get a reply)

thank you …. yess sir i meant the INCREASE in shareholder’s wealth .. and yess i m clear with this approach now …..:) n yess , i d ask on Tutor’s forum if its not concerning with the particular lecture … THANK YOU ðŸ™‚

bowillent says

Pls I’m unable to download the question paper. kindly help me.

John Moffat says

The question is probably in your Revision Kit.

If not, then search on Google typing the date of the exam, or the name of the question (it is still on the ACCA;s website, but they have just removed the link to it).

Raghav says

Hello Sir,

what if you did not put growth rate of 3% whilst doing calculation of MV of year 2013 and simply show as 70c/.10 ?

John Moffat says

Then you would get the wrong answer and you would lose marks!!

We always need to use the dividend growth rate when calculating the market value – the market value is based on expected future dividends and if their is expected growth in dividends then the market value is affected.

I do suggest that you watch the free lectures on the valuation of securities.

boringaccountant says

Hello Sir,

in DVM part b) ii) we have not taken the growth rate in the numerator (70 / 0.10 – 0.03)

Why havent we ??

John Moffat says

Do(1+g) is calculating the dividend in 1 years time.

We are first calculating the price in 3 years time using the formula, and the dividend 1 year later is therefore in 4 years time and is 70c – not 70c plus growth.

boringaccountant says

Yes !! understood !!

Thank u !!

lwitiko says

Mr Moffat, since this was might first time to come face to face with such type of exam question, my comment is that it was a real shocker!!

However, I salute you for breaking up the solution into understandable components in part a and b. However, in part c of your lecture you introduce Modi and Miller theory in Dividend policy of the company. You say that in theory dividend policy does not matter. Is because the WACC uses cost debt in the formulas? I cannt just get my head around this idea.

John Moffat says

Companies can choose different dividend policies.

At one extreme they can pay out all of their profits as dividends – this will mean high dividends, but because they are not retaining and reinvesting the company will not grow, the dividends will not grow, and the share price will not grow (i.e. no capital growth).

On the other extreme, they can pay out a very low proportion of their profits as dividend – this will mean low dividend, but because of the reinvestment of the retained profits there will be high growth. (You will have seen a little numbers example of how this works in my lecture on share valuations)

M&M say that it is irrelevant to shareholders which policy the company follows. If the company chooses to pay low dividends and the shareholders want more cash, then they could always sell some shares.

The cost of debt is not relevant to MM’s dividend irrelevant theory. It is relevant to M&Ms theories on gearing – this is covered in Chapter 19 of our free Course Notes, and the free lecture that goes with it.

lwitiko says

In this lecture for June 2010 Q4 QSX, our calculations identified three prices due to distortion of information. The share price in 2009 is $6.93 (Divi Growth model), actual $6.48 and $7.51 (discount of 70c dividend).

Before I continue, thank you very much for helping me identify 70c as my Div(1+g).

Lastly, kindly help me link the actual share price of $6.48 to semi strong market hypothesis.

John Moffat says

There is no real need to link it (and neither does the examiners answer).

However I can’t really add much to what I say in the lecture at the end of part (b) – if the information about the proposed dividends was publicly available (i.e. strong-form efficiency) then the share price would in theory be higher. Since it is lower this is not the case.

slingswish says

thanks i love this lecture too ! clear and if i don’t understand i can just replay it again ðŸ™‚

acnca says

Hi Prof Moffat,

Thanks for the clarity in the answer which i can now see.

I realise that the DGM formular was what i hadnt slotted in properly by including the growth rate of 4% hence the (*1.04) and also the ex div and cum div prices.

Rgds

A.G

acnca says

Thanks for this detailed work out of the answer to the question.I went ahead and saw a similar qn and approached it as i thought you would using the exmaple you just did on this video but found the examiner gives a different answer(June 2013 Qn 4 a)

My thinking was :0-1-2-3yr Divident = 25 c n increase 4% with ke= 9 %

so mv at year 3 = 25/(0.09-0.04)=500

using the df of 3 discount to zero yr= 500*0.772=$3.86

Total mv = 3.86 * (5000/0.5)=38.6 mll

I however found some inconsistency by the examiner(in my thinking but i could be wrong myself) as seen below(copied)

“””2Â·5/(0Â·09 â€“ 0Â·04) = $50 million .The dividend valuation model value (the capital value of the dividends at year 0) will be:

50/1Â·09^2= $42Â·1 million.The current present value of dividends to shareholders, using the existing 3% dividend growth rate:

(1Â·6 x 1Â·03)/(0Â·09 â€“ 0Â·03) = $27Â·5 million””””

vs

his/her approach in the question you dealt with here(seems inconsistent)

“””2Â·5/(0Â·09 â€“ 0Â·04) = $50 million .The dividend valuation model value (the capital value of the dividends at year 0) will be:

50/1Â·09^2= $42Â·1 million.The current present value of dividends to shareholders, using the existing 3% dividend growth rate:

(1Â·6 x 1Â·03)/(0Â·09 â€“ 0Â·03) = $27Â·5 million””””

In short i would appreciate what you consider the best approach for the question here(2013)

Thanks and sorry for the long story

John Moffat says

You can get the same answer in several ways.

There are two problems in what you have done for the new market value.

First, it is fine to calculate the MV at time 3 using the formula, but you have written 25/(0.09-0.04). However the dividend at time 3 is 25, and so you should have written 25(1.04)/(0.09-0.04). This gives 520.

Secondly, the formula gives an ex div value – so 520 assumes that the dividend at time 3 has already been paid (so it ignores the dividend at time 3).

However there is a dividend at time 3 so that needs bring in (and discounting to time 0) as well. You can either do this separately, or add it to the 520 and then discount for 3 years.

So 520 + 25 = 545. If you discount this for 3 years at 9% you get $4.21 – the same as in the examiners answer.

Mahoysam says

Hi Mr John – I was glad to find a recording on this question as I didn’t like it much when I came across it in my revision kit.

Mr John, just one thing. I am not quite clear on the concept of perfect market and market efficiency types, not sure where can I read about this in the notes? and this seems very important and you have included it in your tips for 2013.. or should I search it and read about it?

Thanks, Maha

John Moffat says

Perfect market is the situation when we are ignoring the costs charged by dealers when we buy and sell shares, and also assuming that share prices react instantly to changes in expectations of dividends (in practice it may take time for share prices to react to new information).

Market efficiency is dealt with on page 9 of the Course Notes.

(Calculations can not be asked on either of these – if either is asked then they will only be a written part of a question)

Mahoysam says

Thank you Mr John – Much appreciated.

Maha

saulat says

sir …… i have a confusion …. pls make me understand !!!!!!!!!!!!!! using Dividend Growth Model we do Do(1 + g) / ke – g right? i did EVERY single question with this approach . but in june 2013 GXG company , examiner didnt use this approach , he just took total dividends divided by ke – g ………. with 4% and 3% growth………. and then compared both , and the difference is Share holder wealth ………. but my first apprach gives me just $500 difference …. by 4% growth it is 25(1.04)/ 0.09 – 0.04 = $5.20 per share ………. and with 3% the price is 25(1.03)/ 0.09 -0.03 = $5.15 per share . number of shares 10,000 and the share holder wealth is 500 in total . sir, if i use this approach , would he deduct my marks ?????? plz urgent answer required ! thanx.

John Moffat says

Yes, you would lose marks.

The market value of a share is the present value of future dividends, discounted at the shareholders required rate of return. You can only use the formula if there is constant rate of growth starting immediately.

In this question there is only constant growth (at 4%) starting in 2 years time and so we need to discount the answer from the formula to get a present vale ‘now’.

Also, the difference between the two values is not the shareholder wealth – it is the increase in the shareholder wealth.

(Unless you are making a comment related to the particular lecture on the page, please ask questions on the relevant ‘ask ACCA tutor’ forum. That way you will be more certain to get a reply)

saulat says

thank you …. yess sir i meant the INCREASE in shareholder’s wealth .. and yess i m clear with this approach now …..:) n yess , i d ask on Tutor’s forum if its not concerning with the particular lecture … THANK YOU ðŸ™‚

John Moffat says

You are welcome ðŸ™‚

naucelime says

The explanations are very clear, thank you!

nesherina says

ohhhh i love this lecture. understand it so quick. tanks much

temi says

This is brilliant, so clear and understandable. thumbs up for ot

fathima says

this was v v useful, thank u v much