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- June 14, 2020 at 11:45 pm
Hello 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 years
Solution 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 share
What have I done wrong and why am I wrong?June 15, 2020 at 9:37 am
You 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
Yes, 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)÷ 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
The 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 🙂
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