June 2012 Question 4 Doubt

I kinda have doubt on part b as well.

With regard to part (a), the PE ratio is the current earnings per share divided by the market value. So using the PE of a similar company and multiplying it by the current earnings of our company will give a market value for our company. With regard to part (b), the market value of shares is the present value of future dividends discounted at the shareholders required rate of return. For the first two years we need to discount the dividends individually, but once the constant growth starts we can use the formula from the formula sheet. (The free lectures on share valuations will help you with both parts) I will upload more answers as and when I have the time available.

Thank you so much :) Appreciate your help. :)

You are welcome :-)

After adjusting the cost of capital using capm (12%) am very much confused where kaplan got 500/1.122 for yr 1 and 1000/1.123 for yr 2. Pls hlp sir.

I don't have the Kaplan book but I do have the original question and answer. Either they have mistyped, or you have misread. The PV of the year 2 dividend should read 500 / (1.12^2) (which is 2 years discounting at 12%) The PV of the year 3 dividend should read 1,000 / (1.12^3) (which is 3 years discounting at 12%) You will know from our free lectures that the market value is the present value of future dividends. You can use the dividend valuation formula for the dividends after time 3 (because there is then constant growth) but you have to discount the dividends at times 2 and 3 separately (there is no dividend at time 1). For the time 2 and time 3 discounting, you could of course have used the tables instead of first principles.

Because the dividends continue after year 3 and are growing!!!! The future dividends are not just in 2 and 3 years time. You really should watch my free lectures on this - you cannot expect me to type out all of my lectures here :-)