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Hi John,
For question Bento, the valuation of Okazu is calculated using the Dividend valuation model, where the growth is estimated based on the growth rate through 4 years of forecast and then reduced by 60% as required by question.
My question here is can I use the other approach, using g = r*b instead? The question gave us Ke = 12% and the retain rate is 75%. Then shouldnt the current growth rate to be estimated at g = 12% * 0.75 = 9%. Then the future growth rate is reduced by 60%, meaning the growth rate to be used for dividend valuation is 9% * 0.4 = 3.6%
I’m not sure if the second approach is considered wrong or not?
Thank you.
The problem is, as you will know from my lectures, that despite symbols used on the formula sheet the growth rate is the retention rate multiplied by the return on reinvestment (which does not have to be Ke).
Having said that, you would get some credit (and although it obviously affects all the following calculations, you do not lose marks twice – you would still get full marks for the rest of the question (assuming you used your figure correctly, and that your workings were clear enough for the marker to follow).Hi John,
Thanks for the feedback. Just to check follow, so the Ke is not considered as return on investment? So far for all the questions I faced with the growth rate formula, the Ke has been used as the rate on investment in the formula
Is there a need to state that we assume Ke to be return on investment if we use the formula in such way?
Thank you
Ke is the return required by shareholders. In theory, in the long term, this will be equal to the return to company gets on reinvestment of retained earnings.
However, in exam questions you are almost always either expected to calculate the growth using past dividends, or are told the growth rate directly. Only if there is no information about it would you use Ke in the formula, in which case you must state that you are assuming that the return on reinvestment will equal the shareholders required rate of return.
hi sir
if we use free cash flow method and assume revenue stay11% after four year in perpetuity. will it be okay? we then deduct percentage of debt 67% (16600/24600) and remaining would be equity cash flows. and then we compare 60 million with that equity cash flows.
In principle it would be OK and you would certainly get some credit for doing that. However the problem is that although the question could be worded better, it is really saying that both the 11% and the 25% are just for the next 4 years. Given that the dividend is reducing from year 5 onwards, the company will be retaining more, and therefore the growth in earnings from year 5 onwards will not stay at 11%.
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