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In part (a), I cannot understand the equation it used to calculate the PV of company value. Could you please explain it?
Why we cannot use 25*1.04/(0.09-0.04)*0.772 ?
Thanks!Normally we use Do(1+g)/(Re-g)
This assumes that Do is the current dividend – so Do(1+g) is the dividend in 1 years time.
It gives a market value now.What you want to do is fine, except that 25×1.04 will be the dividend in 4 years time (25 in 3 years time, inflated for a year). So using that in the formula will give a PV in 3 years time – discount for three years and you get a PV now. That is what you want to do.
The problem is that it would not be including the dividend of 25 in 3 years time.
So….by all means do what you have typed, but then add 25 x 0.772 (the present value of the dividend in 3 years). Then you will get the same answer as the examiner.
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