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A new formed company is expected to pay dividends 20c per share in one year time, 22c in second year time, 25 c in third year tim. Dividends are then expected to grow at constant rate of 2% per annum thereafter. Shareholders required rate of return. Use dividend growth model.
Can you please explain me how to deal with this question as I m not able to get the correct answer.thanks in advance.
The MV is the PV of future dividends discount at the shareholders required rate of return.
So discount the first 3 dividends individually. For the dividends from time 4 onwards use the dividend growth model but then discount the result for 3 years because the growing dividends start 3 years late (at time 4 instead of at time 1).Please watch the lectures because I work through a similar example in the lectures and explain.
Here is my solution
Year Now. Df10% Cf
1. 20c 0.909. 0.182
2 22c. 0.826 0.182
3. 25c. 0.751. 0.182
4. 25c * 1.02= 25.5. 0.683. 0.174
Until here I did after that I am not understanding. I see your lectures regarding this type of questions but that question in your lectures I find easy as constant cf is given for 2 yrs but here e are diff dividends. Can you please explain now how I should do further calculation.thanks in advance
Assuming that you have actually watched the lecture then I suggest that you watch it again, because the only ‘harder’ thing about this example is that you have to discount the first 3 dividends individually, which you should find trivial. Dealing with the dividends from time 4 onwards is exactly the same approach as explained in the lecture.
You have discounted the first 3 dividends (but you have got year 3 wrong – 25c x 0.751 does not equal 0.182).
I have no idea what you have done for time 4 onwards. The dividend carries on after time 4, inflating at 2% per year and you are supposed to use the growth model formula just as I do in the lecture. Do is 25c, g is 2%, and r is 10%.
As I wrote before, the answer from the formula is the PV in 3 years time and so needs discounting for 3 years.Then you simply add up all the PV’s to get the market value.
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