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Hello Sir,
for Part A of the question, we are required to calculate the equity value using DV Growth,
Ok simple straight forward arithmetic, BUT,
why do we not consider the ex div market value ??
In case they had not mentioned to use the Div Growth or any other model, and we were required to calculate the mkt value,
the first thing that would come to mind is the ex div mkt value already mentioned of 8.30$
or if assuming the question stated that the co. is about to pay a dividend of 66 cents, and 8.30$ is the cum div mkt value, then would we have calculated just 8.30 – .66 OR would we have done the DVG model with taking 97% of 66 cents..?
I hope you get what I am trying to ask 😀 !!
I would also like to “THANK U FOR REVISION LECTURES AND NOTES” – Really Helpful !!
regards,
Another question: MCQ
19 Luke Co has 8% convertible loan notes in issue which are redeemable in five years’ time at their nominal value of
$100 per loan note. Alternatively, each loan note could be converted after five years into 70 equity shares with a
nominal value of $1 each.
The equity shares of Luke Co are currently trading at $1·25 per share and this share price is expected to grow by 4%
per year. The before-tax cost of debt of Luke Co is 10% and the after-tax cost of debt of Luke Co is 7%.
What is the current market value of each loan note to the nearest dollar?
A $92
B $96
C $104
D $10Answer is 96$, and I know how to get to it, but why do we not incorporate tax in 8$ interest……It is a company, so tax should be charged, hence 8 (1-.3) = 5.6
regards,
And 1 more :D,
The home currency of ACB Co is the dollar ($) and it trades with a company in a foreign country whose home currency
is the Dinar. The following information is available:
Home country Foreign country
Spot rate 20·00 Dinar per $
Interest rate 3% per year 7% per year
Inflation rate 2% per year 5% per year
What is the six-month forward exchange rate?
A 20·39 Dinar per $
B 20·30 Dinar per $
C 20·59 Dinar per $
D 20·78 Dinar perAnswer is 20.39,
But, why do we take interest rates rather than inflation… ?
or, precisely, why Can’t we take inflation rates here. ? in the example in the lecture inflation rates were used for the change in 1 month forward rates (I had the impression interest OR inflation rates should give the same answer, meaning increase in level of interest will effect the inflation of the same currency, hence the net effect between two currencies should be nil, so any could be used, I was surely wrong, but why ?? :S)
FYI, with inflation we get $20.30
First question:
We always use the dividend growth model to calculate the market value unless you are told in the question to do differently.
Question 2:
Market values are always fixed by the investors, and company tax is irrelevant to them – they receive the full interest.
Tax is only relevant when we are calculating the cost to the company (because the company gets tax relief on interest).
Question 3:
If we are forecasting a future spot rate, then we use inflation rates (purchasing power parity).
However, forward rates are always calculated using interest rates (the bank is doing money market hedging with the money which uses the relative interest rates).
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