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Hello sir this question is driving me crazy, I can’t understand the proposed calculation in part a , the examiner has modified the formula that’s normally used and in numerator Do( 1+g) is not being used instead Do only but growth subtracted in denominator, and even if this is true how can a subtraction between proposed and current be increase in shareholder wealth specially when proposed is not even taking account of growth
The numerator is the dividend in one years time. Usually we know the time at time 0 and therefore the dividend in 1 years time is Do(1+g).
However, if instead we know the dividend in 1 years time then we use this as the numerator.When we have the dividend in 1 years time as the numerator (either as Do(1+g) or directly as D1) then the formula gives the present value at time 0 which is the current market value.
In this question we know the dividend in 3 years time (which is 2 years later than D1) and therefore the formula gives a market value 2 years later – i.e. at time 2. So the answer then needs discounting for 2 more years to get the current market value.
The proposed market value is certainly taking account of growth – it is the denominator that deals with the growth. (If there was no growth you would simply divide by the cost of equity).
The free lectures will help you. Our lectures are a complete course for Paper F9 and cover everything needed to be able to pass the exam well.
Hello Sir John,
I too had a difficulty with that question and your explanation above has clarified my doubts.
but, I haven’t still understood how they got the current present value of dividends to shareholders. This is their working :(1.6 x 1.03) / (0.09 – 0.03) = 27.3 million.
I don’t understand how they got the 1.6.
Kindly help me clarify that too sirThanks in advance .
The current dividend is 1.6M in total from the question.
The answers has used total dividend and therefore calculated total market value. Alternative you could have calculated dividend per share and used that to calculate MV per share (and then multiplied by the number of shares to get the total market value).
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