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Cant Co has a cost of equity of 10% and has forecast its future dividends as follows:
Sir please help, i don’t understand why the answer is C for the below question.
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
What is the current share price of Cant Co using the dividend valuation model?
A $7·35
B $5·57
C $6·11
D $6·28The market value is always the present value of future dividends discounted at the shareholders required rate of return.
When there is a growing dividend we can use the dividend valuation formula given on the formula sheet.
For the 0.50 which is growing.
If the question has simply said “a dividend of 0.50 has just been paid” then we would simply use the formula and would get a PV of (0.50 x 1.03) / (0.10 – 0.03) = 7.36
However instead of a dividend having just been paid, we have a dividend of 0.50 in 3 years time, which is 3 years later. So the 7.36 is a value 3 years later as well.So now you need to discount as follows:
Year 2: 0.25 discounted for 2 years at 10% = 0.21
Year 3: 0.50 + 7.36 = 7.86 discounted for 3 years at 10% = 5.90So total MV = 0.21 + 5.90 = 6.11
John,
I hope you don’t mind me tagging on to another students question but is far to assume from this and many other questions I am starting to see that the F9 examiner credit 1/2 mark per calculation?
I am have completed several questions recently and your example above is a great example where we are performing 4 calculations for two marks or 12 calculations for 6 marks. The reason I ask is to help students including myself understand the examiners approach to marking..
Thanks John
You cannot rely on it being 1/2 mark per calculation – it does vary (although it is a good guideline to work on I suppose).
What is does highlight is the importance of setting out your workings neatly in a way that the marker can follow. It is the workings that get the marks – not the final answer 🙂
Also, if you get stuck on a question, then there is no need to panic. If you have done half the workings then you are going to get the 50% to pass, even if you got stuck and didn’t manage to finish.Understood, I can’t help but think the examiner like students to work for their marks with several smaller calculations before you arrive at the figure you actually require ?
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