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Dear Sir,
Please show me how we arrive at the Answer here,
18) A Company has just paid a dividend of $0.3 per share.
Shareholders are expecting the dividend to remain at $0.3 Per share next year but to increase at an average rate of 3% per annum there after. Shareholder Required rate of return is 12% and the rate of corporation tax is 12%.What will be the current market value per share?
a) 2.33
b) 2.63
c) 2.56
d) 2.71Answer given is C yet I thought it would have been b.
Firstly, you have copied the question wrongly – the dividend is 23c per share (not 30c per share).
If the dividend was growing immediately then the answer (using the dividend growth formula) would indeed have been 2.63.
However, growth does not start until a year from now, and so 2.63 is the value in 1 years time.
So then we have to use the basic rule that the market value is the present value of expected receipts discounted at the required return.
The value in 1 years time is 2.63, plus the expected dividend of 0.23 in 1 year gives a total in 1 years time of 2.86. Discount this for 1 year at the required return of 12% and you will get $2.56.(This has been a common ‘trick’ of the examiner in recent exams.)
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