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- February 22, 2021 at 2:46 pm #611315
Cant Co has a cost of equity of 10% and has forecast its future dividends as follows:

Current year: No dividend

Year 1: No dividend

Year 2 $0·25 per share

Year 3: $0·50 per share and increasing by 3% per year in subsequent yearsWhat is the current share price of Cant Co using the dividend valuation model?

A $7·35

B $5·57

C $6·11

D $6·28I cannot calculate the present value of the current share price discounted by 10% using DVM.

DVM = ($0.50 x 1.03) / (0.10 – 0.03) = $7.35

Should I apply the 3rd year discount factor to discount the current share price of $7.35 to 3 years discount rate?

PV = $7.35 / (1+10%)^3 = $5.52

Now, this is where I stuck!

February 22, 2021 at 4:11 pm #611329PV = $7.35 / (1+10%)^3 + ($0.25 x 0.825) = $5.765

The PV of the year 3 dividend, discounted at 10% per year is ($7.35 x 0.752) = $5.52

The PV of the year 2 dividend, discounted at 10% per year, is ($0.25 x 0.826) = $0.2065.Is that okay?

February 22, 2021 at 5:26 pm #611349Why are you attempting a question for which you do not have an answer? You should be using a Revision Kit from one of the ACCA Approved Publishers – they have answers and

explanations 🙂What you have done is fine, except for the fact that your &7.35 is the PV at time 2 and therefore need discounting for 2 year and not for 3 years.

I do work through and explain examples like this in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.

February 22, 2021 at 8:36 pm #611362Sir, I got this question while looking into the examiner report and I did watch your lecture on chapter 15. But, I have serious misunderstandings about this question.

This question is answered in the examiner report [March 2016] as follows:

DVM = $0.50 / (0.10 – 0.03) = $7.14

PV = $7.14 / (1+10%)^2 + ($0.25 / 1+10%)^2 = $6.11 [correct answer is C][important questions]

Here market value using DVM has been calculated as $7.14 without taking growth in the dividend to get the dividend for year 4, BUT we have deducted the growth from the cost of equity-like this (0.10 – 0.03). IF we are not taking the growth in the dividend calculation then why are we deducting it from the cost of equity [because it has no relevance]?In my last response, I calculated market value with growth which answers in $7.35 [which u said is correct] and I need to calculate the PV to two years.

Lastly, I have issues with the time of the discount factor. In question, three years time is given where we are at current year time [let say year 0]. So, why do we discounted the PV to year 2 and not year 3 because from Year 0 it is 3 years to be at year 3 [I’m stuck here, your help is needed] 🙁

I am not sure whether we are calculating PV from Year 0 or Year 1.

February 23, 2021 at 8:50 am #611405The numerator in the dividend valuation formula (Do(1+g)) is the same as the dividend in 1 years time.

So if the first dividend was 0.50 in 1 years time (then growing at 3% per year), as opposed to the current dividend being 0.50, then the MV now would be 0.50 / (0.10 – 0.03) = 7.14.

However, the first dividend is not in 1 years time but is two years late and is in 3 years time.

The 7.14 is the PV two years later – i.e. at time 2 instead of time 0.

So the PV ‘now’ is 7.14 discounted for 2 years at 10% which is $5.90.

In addition there is $0.25 in 2 years time, and the PV of this is 0.25 discounted for 2 years at 10% which is $0.21.The total MV is 5.90 + 0.21 = $6.11

February 26, 2021 at 9:55 am #611778Thanks for your answer Sir 🙂 BUT I still have a slight problem with the year’s time!

Since we are in [year 0] & the first dividend will be in [year 2] of $0.25 which is needed to be discount to PV of [year 2]…

BUT in [year 3] dividend of $0.50 is needed to discount to PV of [year 3] NOT [year 2] because this is the dividend in year 3 [confusion why year 2 when discounting as u wrote it is year 2?]

From the view that we are now in [year 0], the dividend of $0.50 is in the [year 3] so we should discount it to the PV of [year 3]. Is not it?

Please state why we need to discount [year 3] dividend of $0.50 to PV of [year 2]? Is there any logical explanation behind this!?

February 26, 2021 at 2:34 pm #611818Had the first 0.50 been in 1 years time we would have used the formula to arrive at a PV ‘now’ i.e. at time 0.

Given that the first 0.50 is in 3 years time (which is 2 years later that in 1 years time) the result of using the formula is the PV 2 years later i.e. time 2 instead of time 0.

Therefore we need to discount the answer by 2 years to get the PV at time 0.

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