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J PLC paid a dividend of 250,000 this year. THe current return to shareholders is 14%. Compute the expected valuation of J plc if the dividend is expected to grow at 3% for three years and 2% afterwards.
Sir could you please explain in detail?
The market value is the present value of future dividends discount at the required return of 14%.
The dividend in 1 years time is 250,000 x 1.03 = 257,500
In 2 years time is 250,000 x (1.03^2) = 265,225
In 3 years time is 250,000 x (1.03^3) = 273,182These three you can discount in the normal way at 14%.
For the dividends from time 4 onwards you need to use the dividend valuation formula (from the formula sheet) with Do = 273,182; g = 0.03; and Re = 0.14.
However, this would give the PV if the next dividend was in 1 years time. Here it will be in 4 years time (3 years later). So the answer from the formula has to be discounted for 3 years at 14% to get the present value.
Finally, add the present value arrived in the last paragraph to the present value of the first 3 dividends, and there you have your answer 🙂
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