F9 question from OpenTution Mock exam

Q19) year 1-5 Interest (8% x 100) = $8 df @ 12% 3.605 3.605 x $8=$28.84 year 5 RV (110% x 100) = $110 df @ 12% 0.567 0.567 x $110=$62.37 P0 = ($28.84+$62.37) x ($400000/$100) = $364840

Yu Huey's answer to the first question is correct. With regard to the second question: The dividend growth rate is fourth root of (24/20.51) - 1 = 0.04, i.e. 4% The shareholders required rate of return = 3% + (0.5 x 8%) = 7% The dividend just paid is 24c If you put these in the dividend growth model formula you get a market value per share of $8.32. Therefore a total market value of 4M x 8.32 = $33.28M

Tutor! This is one that I am not getting your suggested answer. Four years ago dividend was 20.51; thus 3 root of (24/20.51) - 1, resulting a 5.4% growth rate. I substitute and calculated the market value of the share to be $15.81 - $63.24 capitalization.

Sorry, but 4 years ago is not 3 years ago, What I wrote before is correct. Tutor.

How do I copy and paste the questions I got wrong? I can't do :(

It depends what operating system you are using. However there should not be a problem copying and pasting.

PQR has demand 7500 units per month each unit cost $5 and are $100 per order and the inventory holding cost is 10% of purchase price per year there is a lead time of 30 days between placing and order and reciving delivery .if they order the eoq each time how frequently will they palce an order ( nearest dayz)

Sir John!!!!! These are the things that may have been preventing me from scoring the required marks for success. Under exam pressure, it's even worse - hence marginally failed. I will ensure that I follow the ask the tutor forum, where the students questions are answered. Thank very much. Regards,

Hadia: you have posted the same question three times! Twice here, and again in a new thread. I have answered your other post already. (If you have kept repeating the post to try and get a faster answer, then it will not work. I always answer within 24 hours (we only promise within 48 hours). I cannot sit at the computer 24 hours a day :-) )

Sir, sorry but could you explain answer to 1st question? Why is the interest of $8 not taken post tax i.e $5.2? And why is the rate of 12% used straight away unlike what we do to find out the cost of irredeemable debt ? Thanks

Sir, in your explanation (post: November 1, 2014 at 7:03 pm) for question 2, why did you not deduct risk free rate from market premium of 8%?

Accountaholic: Your first question: It is investors who fix the market value. The market value is the present value of the expected receipts discounted at the investors required rate of return. The investors are not subject to company tax - they receive the gross amount of the interest. (You should watch the free lecture on the valuation of debt).

Accountaholic: Your second question: The market premium is the premium (excess) of the market return over the risk-free rate.

Dear Tutor and Yu Huey Regarding Q19 You both did not consider the tax rate in which it would be $8*0,65=5.2 and then 5.2*3,605, wouldn't it be the correct way? Regards, Ramil

The tax is not relevant and the answer we gave is correct. It is the investors who fix the market value, and they receive the full interest. The tax is only relevant when we calculate the cost of debt to the company - the company gets tax relief on the interest.

@johnmoffat said: With regard to the second question: The dividend growth rate is fourth root of (24/20.51) - 1 = 0.04, i.e. 4% The shareholders required rate of return = 3% + (0.5 x 8%) = 7% The dividend just paid is 24c If you put these in the dividend growth model formula you get a market value per share of $8.32. Therefore a total market value of 4M x 8.32 = $33.28M

John, why do you ignore risk fee rate in second part of formula? I suggest it should be as in Formulae sheet for exam CAPM 3%+0.5 (8%-3%) = 5.5% (not 7%) So MV of share of $16.64 and capitalisation is $66'560'000. Am I correct?

No you are not correct. The question says that the market premium is 8% (not that the market return is 8%). The market premium is the excess of the market return over the risk free rate.

Sir pls explain the following 2 questions for me. Rl Co has an issue 6% redeemable bonds quoted at 120% ex int. Which of the following statement is consistent with the above information? a. Interest yield 6% redemption yield 8% b. Interest yield 5% redemption yield 8% c. Interest yield 5% redemption yield 4% d. Interest yield 6% redemption yield 4% A company has an earnign yield of 12.5%. The average PE ratio for similar company is 9.5 Which of the following statements regarding the value of shares is true? a. It is impossible to comment on the value of the shares b. It is likely that the shares in the company are over valued c. It is likely that the shares in the company are fairly valued d. It is likely that the shares in the company are under valued

RL Plc has in issue $400000 8% bonds redeemable in 5 years time at a premium of 10%. Investors require a return of 12% p.a. The rate of corporation tax is 35%. What is the total market value in issue? This is wht I did: 1-5 Interest 8(1-0.35) x 3.605 = 18.746 Repayment = 110 x 0.567 = 62.370 MV = 81.116 Total market value = 400000 x (81.116/100) = 324464 BUT CORRECT ANSWER IS GIVEN AS 364840. Where did I go wrong?

RL Plc has in issue $400000 8% bonds redeemable in 5 years time at a premium of 10%. Investors require a return of 12% p.a. The rate of corporation tax is 35%. What is the total market value in issue? This is wht I did: 1-5 Interest 8(1-0.35) x 3.605 = 18.746 Repayment = 110 x 0.567 = 62.370 MV = 81.116 Total market value = 400000 x (81.116/100) = 324464 BUT CORRECT ANSWER IS GIVEN AS 364840. Where did I go wrong? Why is the tax not taken into account in the suggested answer?

The tax is not relevant when calculating the market value (it is only relevant when calculating the cost of debt). The reason is that it is investors who fix the market value and they are not affected by company tax. I do suggest that you watch our free lectures on the valuation of securities.

@johnmoffat said: Yu Huey's answer to the first question is correct. With regard to the second question: The dividend growth rate is fourth root of (24/20.51) - 1 = 0.04, i.e. 4% The shareholders required rate of return = 3% + (0.5 x 8%) = 7% The dividend just paid is 24c If you put these in the dividend growth model formula you get a market value per share of $8.32. Therefore a total market value of 4M x 8.32 = $33.28M

Hi John, Just to clarify, there is four years growth because the dividend has just been paid. If it were about to be paid would it be 3 years growth. I know this sounds like a really stupid question but I just want to make sure I have it clear in my head! Thanks in advance!

No - for the growth rate it makes no difference whether the dividend has just been paid or is about to be paid. It is simply that there is 4 years between the two dividends. When you put it in the formula, then Po is always the ex div value (the value assuming the current dividend has just been paid) but that is nothing to do with the calculation of the growth rate.