June 2010 exam, question 4 — OpenTuition Forums

Nneilsolaris12y ago

Hi, I'm slightly confused about part (b) to question 4 in the June 2010 exam (QSX Co). I correctly answered part (i). For part (ii) it ask you to work out the share price using the dividend growth model if the proposed change in dividend policy is implemented. Basically, is it 2009, and they are not going to pay any dividend until 2013, at which time they will pay 70c per share with a 3% growth thereafter. The cost of equity is 10%. The way I answered it was to work out the share price in 2013 first. I calculated it this way. (0.70 * 1.03) / (0.10 - 0.03) = $10.30. To get the 2009 share price I multiplied by the 4 year annuity factor. $10.30 * 0.683 = $7.03. In the answer, they worked out the 2012 share price with this calculation. 0.70 / (0.10 - 0.03) = 10 * 0.751 = $7.51. What I am confused with, is why is my answer different to the official answer? I know they went about it a slightly different way to me, but did I make a mistake somewhere? Also, when the question asks me to calculate the share price, how do I know exactly what the current year is? I had to think for a long time whether the current date is 2009 (the last year of the financial information provided), or 2010 (the year of the exam). Thanks a lot for your help.

NNizar12y ago#1

what does it means by CLOSING EX DIV SHARE PRICE. Why me must use the share price in 2007 to calculate dividend yield in year 2008?

John MoffatTutor12y ago#2

Your way is fine, except for one thing......... You have used the growth formula, but the growth formula gives us the ex div value. So your figure of 10.30 is the value in 4 years, after paying the dividend. However, the are paying a dividend in 4 years, and so you need to add on to your value of $7.03 the present value of the dividend of $0.70 in 4 years. The present value of this is $0.70 x 0.683 = $0.48 This gives a total market value now of $0.48 + $7.03 = $7.51 (which is the same as the examiners answer) (You will know from my lectures that the market value of a share is the present value of future dividends. The formula does this for you, provided there is constant growth) I hope that makes sense :-)

John MoffatTutor12y ago#3

nizarsalleh: The ex div price is the market value assuming that the current dividend has just been paid. The closing price is the market value at the end of the year (and therefore the market value at the start of the following year). The dividend yield is calculated as the dividend for the year / the market value at the start of the year.

NNizar12y ago#4

what about the other formula? the earning yield, earning per share and other formula that involve share price, do we also use the share price before the dividend is paid? (cum div share price)

John MoffatTutor12y ago#5

You assume that the market price at the start of the year is ex div (not cum div - the price goes ex div as soon as the dividend is announced). The earnings per share does not use the share price at all - it is earnings divided by number of shares. We use the ex div value for other formulae that use the share price.

Nneilsolaris12y ago#6

Thanks for explaining that to me. I think I've got it, but I'll probably have to sit down and think a bit more for it to properly sink in! I will watch your relevant lecture again too.

John MoffatTutor12y ago#7

OK - ask again if it still does not make sense when you have had time to think about it :-)

Nneilsolaris12y ago#8

Thanks, I'm pretty sure I understand now! Whether I'll get it right in the exam is another question!

John MoffatTutor12y ago#9

I am sure you will get it right :-)

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