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Hi,
The question is ; calculate the value of company using dividend model,
Info;
Forecast financial info to the company is as follows,
Dividends yr1 nil
Yr2 500
Yr3 1000
The company is optimistic dividend will increase AFTER year 3 at constant 3% per year. Cost of capital 12%Solution:
Yr 2 : 500/1.12*2
Yr3: 1000/1.12*3
Yr3 PV of dividend (1000×1.03/0.12-0.03) =11,444.444
11,444.44/1.12*3= 8145
Then they are just adding all the figures together after discounting to PV.My question was why is it dividend growth model used for year 3? I assumed it was year 4 and not year 3 again as yr3 was given as I assumed questions states AFTER yr 3.
They have ÷ with yr 3 cost of capital and not 4?
My other question was to value the company do you account for all 3 yrs dividend ?Thank you
The dividend growth model gives the PV ‘now’ when the first dividend is in 1 years time.
Here the first ‘growing’ dividend is in 4 years time (which is 3 years later) and therefore the formula gives the PV 3 years late – i.e at time 3 instead of at time 0. Therefore we need to discount for 3 years to get the PV ‘now’.
Yes – the value is the PV of all future dividends.
This is all explained in my free lectures on the valuation of securities. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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