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- This topic has 3 replies, 2 voices, and was last updated 2 weeks, 2 days ago by John Moffat.

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- June 14, 2020 at 11:45 pm

anazoricParticipantHello John, this is MCQ 225 from the BPP (Sep ’19 to Jun ’20) kit.

Cost of equity 10%

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 yearsSolution from the kit:

(0.826 x 0.5)/(0.1-0.03) + (0.25 x 0.826) = $6.11 per share.My solution, using open tuition notes as a guide:

(0.5 x 1.03)/(0.1-0.03) x 0.826 + (0.25 x 0.826) = $6.28 per shareWhat have I done wrong and why am I wrong?

June 15, 2020 at 9:37 am

John MoffatKeymasterYou should not have multiplied the 0.5 by 1.03 in the first term in your equation. Then you would have arrived at the correct answer of $6.11 per share.

The reason is that had the first of the growing dividends been in 1 years time, the formula would have given the PV ‘now’. The term Do(1+g) is the current dividend plus 1 years growth and is therefore the dividend in 1 years time.

Here, the first growing dividend is at time 3 instead of at time 1, and therefore the formula gives the PV two years later i.e. at time 2 (and so needs then to be discounted for 2 years). The term Do(1+g) is the dividend at time 3 instead of at time 1 and is therefore $0.50 (not $0.50 plus growth).

You say that you have used our notes as a guide, but did you watch the free lectures that go with the notes (because I do explain this in the lectures). It is pointless to use the notes without watching the lectures – they are only lecture notes and it is in the lectures that I explain and expand on the notes.

June 17, 2020 at 5:58 pm

anazoricParticipantYes, I watched the videos with the notes.

I am talking about Chapter 15, page 78, example 7 of the notes.

They calculated p2 as 20c(1.04)梅 0.15-0.04 then, multiplied by 0.756.

But with the BPP MCQ, they didn’t multiply the dividend by the growth rate first. Please John kindly explain.

June 18, 2020 at 8:25 am

John MoffatKeymasterThe alternative way is to do what you were doing.

However using (0.5 x 1.03)/(0.1-0.03) would give the value in 3 years time of the dividends from time 4 onwards (because it is using the dividend at time 3 as being Do).

So the answer would then need discounting for 3 years to get the PV (not 2 years).Having got the PV of the dividend from time 4 onwards, you then need to add on the PV of the dividend in 2 years time (which you have done correctly) and also add on the PV of the dividend of 0.50 in 3 years time.

If you do that you will again end up with the same answer 馃檪

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