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Hi Sir,
This question says that in year 3, dividend is $0.5 per share and increasing by 3% per year in subsequent years. So I calculated the price with dividend growth from year 4 and discounted it, my NPV was:
$0.25*0.826 + $0.5*0.751 + ($0.5*1.03/0.07)*0.751 = $6.107This is the same result as the kit, but their explanation for this question confuses me as they use P=D1/(r-g) only, without multiplying 1.03.
Could you let me know if my calculation is correct please? If not, which part did it go wrong and why did BPP calculate differently?
Also, in the exam, how should we do the rounding in our calculations for type in MCQ questions please? Like what if I discount using 0.5/(1.1)^2 instead of *0.826 and the final total is slightly different in the second decimal?
Thank you so much for your help.
Your calculation is correct and is fine.
If the first growing dividend had been at time 1, then when using the formula to get the MV at time 0 the numerator is Do(1+g) and this is the same as the dividend at time 1.
Here, the first growing dividend is at time 3 and they have used the dividend at time 3 and so arrive at a MV at time 2, which they then discount for 2 years.
Either approach is fine, and since you are obviously happy with the approach that you have taken then stick with that 🙂
For prices per share you should always round to the nearest cent. For other questions, the rounding will be forced on you by the choice of answers, or the question will tell you to round to (for example) the nearest $100. It will not matter whether you take the discount factors from the tables or whether you calculate them using the formula.
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