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Company B is an unquoted shoe manufacturer it has also suffered in the recent recession but the directors are confident that the company is passed the worst and growth lies ahead
Earnings are expected to be 12.5 million next year and expected to grow at 2% per annum
dividends will be 5 million for each of the next three years and then expected to grow at 3% thereafter
David Has located a similar listed company that has an Earnings yield of 12% and the cost of equity of 14% calculate the value of company using DVM
Ans: MV= 5*annuity factor for 3 years+value of growing perpetuity * 3 year simple discount factor
(Please explain y annuity factor and discount factor is used)As always, the MV is the PV of the future dividends discounted at the shareholders required rate of return.
Given that there is a constant divided of 5M per year from years 1 to 3, we discount this flows by multiplying by the 3 year annuity factor at 14%.
From years 4 through to infinity there is a dividend of 5M per year growing at 3% per annum, and therefore to get the PV we use the dividend growth formula. However the formula gives a PV now (time 0) when the first dividend is in 1 years time. Here, the first growing dividend is in 4 years time (which is 3 years later than in 1 years time) and therefore the answer from the formula is giving a PV 3 years later (so at time 3 instead of at time 0). Therefore we need to discount the answer for 3 years at 14% to get the PV.
I do work through similar examples explaining this in my free lectures on the valuation of securities. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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