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Hi Sir,
Could you help me with the following question please:
A company has just paid a dividend of $0.23 per share.
Shareholders are expecting the dividend to remain at $0.23 per share next year, but to increase at an average rate of 3% per annum thereafter.
Shareholders required rate of return is 12% and rate of corp tax is 25%
What is the current market value per share
The answer = $2.56
after using the dividend growth valuation model I get 0.23 x 1.03 / (0.12 – 0.03) = $2.63.
I thought that when working out the current market value we need to get to cum div so I added Do i.e. $2.63 + $0.23 = $2.86
Can you please advise me as to where I am going wrong?
Thanks for your time
The formula on the formula sheet is not strictly correct (but we have to live with it!).
Instead of Do (1+g) on the top of the formula, it should strictly be written as D1 (where D1 is the dividend in 1 years time).
Usually it is not a problem because the dividend in 1 year is usually the current dividend together with 1 years growth.
However in this question the dividend in 1 years time is not 23 plus growth, it is actually 23c.
So the formula give 23 / (0.12 – 0.03) = $2.56.
(The examiner has done this quite a few times recently)
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