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Question paper: https://www.accaglobal.co.uk/content/dam/acca/global/PDF-students/2012/december2007ques.pdf
Answers: https://www.accaglobal.co.uk/content/dam/acca/global/PDF-students/2012/december2007ans.pdf1a) We are given share price, why did we calculate an imputed value?
1b) it gives ordinary share price but then a different value is calculated using the dividend growth model, why is that?We calculated the implied (not imputed) value using the PE ratio, because the question asked for the value of the company using the PE ratio!
With regard to the fact that the dividend growth model gives a different share price than the current share price, the examiners answer explains that in the last paragraph of his answer to part (b).
There are various possible reasons – firstly the share price depends on shareholders expectations of growth. We have calculate the growth rate based on past dividends, but that does not mean that shareholders will necessarily be expecting that rate of growth. Secondly, shareholders may have knowledge about the takeover and will therefore have built this expectation into the share price. Thirdly, it assumes an efficient market, which is not the case in practice.1a) I don’t get the question. Surely you would just multiply ordinary share price by number of ordinary shares (3.30 x 5 mil) to get the value of the company
1b) P0 in the growth model is the ex-div market price. Yet we are told the ex-div share price is 3.30. So shouldn’t P0=3.30?
Are you saying P0 is only a theoretical value due to the reasons above?But the questions specifically asked to you value it using the dividend growth model and using the PE ratio (the other way you could be asked to value it – not in this question – is on a net assets basis)
Just because the share price on the stock exchange is $3.30 does not mean that you could or would by the company at that price. As soon as shareholders realised someone wanted to buy the company the share price is likely to rise and so you would have to offer more. Similarly just because the share price is 3.30 does not mean you would be prepared to pay that much per share for the company.
Yes – the dividend growth model is theoretical. If it worked ‘perfectly’ then nobody would make any money speculating on shares.
Have you studied this topic yet? If not then I really do suggest that you read Chapter 16 of our Course Notes and watch the lecture that goes with it.
Ah, I missed the chapter 16 lecture. It’s making more sense after a quick glance at the video, thanks.
Dear John,
I will be obliged if you could clarify this.
If the question gives EPS, Dividend and Market Price for last 4 years, which should be used to calculate Growth in order to use DGM model.I am actually referring to Dec 2014 Qn.2 (part B) question where if you take EPS it gives a negative growth and I got stuck there and referred to the answer sheet and found that Market price is used to calculate growth. Please find below the extract of the question.
Recent information on the earnings per share and share price of Par Co is as follows:
Year 2011 2012 2013 2014
EPS cents) 64 68 70 62
Year-end share price ($) 9·15 9·88 10·49 10·90The answer sheet has calculated growth as below
(a) Average historical share price growth = 100 x ((10·90/9·15)1/3 – 1) = 6% per yearIf you try 62/64 = 0.968 and take its cube root you get 0.989 and if you deduct 1 from it you get a negative figure. In the exam hall you will get stuck here. I never saw a question where growth is calculated from market price in the past.
Can you please give the rationale behind using market price to calculate growth, and also if you get EPS like above how to calculate growth in such a case where EPS or Dividend is showing a negative growth.
Thanks and regards
KrishnanIf you are calculating the market value of a share as of today using the dividend growth formula, then you use the dividend growth rate.
However that is not what we are doing in this question. We are valuing convertible debt and therefore we need to determine what investors expect the market value of the shares to be on the date of conversion, and for this we use the growth in market value because that is what they will most likely be basing their expectations on.The earnings growth rate is therefore not relevant, and therefore I would not get stuck there in the exam.
You will not get negative growth rates in the exam.
(Not relevant for this question, but in the long-term you would expect earnings growth rates, dividend growth rates, and market value growth rates to be the same – I explain why in the free lectures. However, in the short term there are all sorts of reasons why they may not be the same – changes in the number of shares, changes in dividend policy, being just two examples.)
I do suggest that you watch the free lectures (using the free lecture notes that go with them). I do go through the valuation of convertible debt.
Thanks for the quick reply, Sir. I got the logic.
In F9 paper every time some new thing is put in question whether its NPV question or cost of capital question.
So can I generalise that in questions relating to calculation of convertible bonds, if share market price and dividends both are given for last 4 years, we will use share market price rather than dividend to calculate growth.
Warm regards
Krishnan
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