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The company needs to raise $3200000.There are two options
GXG Co could suspend dividends for two years, and then pay dividends of 25 cents per
share from the end of the third year, increasing dividends annually by 4% per year in
subsequent years. Dividends in recent years have grown by 3% per year.
Q)Using the dividend valuation model, calculate the value of GXG Co under option 1,
and advise whether option 1 will be acceptable to shareholders
I get the current market value.What i could not understand is when we advise on a project based on shareholders wealth we need to find the market value if the project is continued.In the text book they did not include the 4% growth
2.5/(0.09 – 0.04) = $50 million (cost of equity is said in the question to be 9% but the growth is only deducted.Shouldnt the formula be
Why wasnt the growth included ?
Was it because there were no dividends paid for the last two years? if so why was the cost of equity deducted?
When we use the dividend valuation model it gives the MV ‘now’ when the first dividend is in 1 years time, and the numerator (Do(1+g)) is the dividend in 1 years time (the current dividend plus a years growth).
Here, the first dividend is in 3 years time and is an actual 25c (not 25c plus growth) and therefore since the first dividend is 2 years later (time 3 instead of time 1) the result from the formula is the PV in 2 years time and so needs discounting for 2 years to get the PV ‘now’. Also since the dividend in 3 years time is an actual 25c, we do not need to multiply it by (1+g).
I do explain all this in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.