FF Qs & As Topic 3 Part 2 - FEEDBACKFORUM...

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FEEDBACK FORUM  TOPIC 3 - VALUATION PART 2 - EQUITY Question  1 How much extra would the share price be for two otherwise identical securities with  each having just paid a dividend of $0.20 p.a. per share, but where one company has  positive dividend growth of 2% p.a. The required rate of return on both shares is 15%  p.a.  a) $1.33  b)  $0.35  c)  $0.23  d)  $0.16  Share 1:   No growth in dividends, dividend is constant at $0.20 p.a. This share is a perpetuity Use PV of a perpetuity formula to find the price: 33 . 1 $ 15 . 0 20 . 0 $ 0 = = = e r D P Share 2: Constant growth in dividends of 2% p.a. Use constant growth in dividends pricing formula to find price: ( 29 ( 29 57 . 1 $ 13 . 0 204 . 0 $ 02 . 0 15 . 0 02 . 0 1 20 . 0 $ 1 1 0 0 = = - + = - = - + = g r D g r g D P e e Therefore, the difference is $1.57 - $1.33 = $0.24 Question  2 The last dividend paid by Buyrite Ltd was $1.00.  Buyrite’s growth rate is expected to  be 5 percent p.a. for 2 years, after which dividends are expected to grow at a rate of 10  percent p.a. forever.  Buyrite’s required rate of return on equity is 12 percent.  What is  the current price of Buyrite’s shares? a) $33.33 b) $42.25 c) $50.16 d) $58.75 Always start from D 0  (i.e. the most recent dividend)   D 0  = $1.00 D1 = $1.00 (1+0.05) = $1.05 D2 = $1.05 (1+0.05) = $1.1025 D3 = $1.1025 (1+0.10) = $1.2128 1
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To find current price, i.e. P 0 , we must find the PV of D 1 , D 2 , and all the constantly growing  dividends from Year 3 onwards. Remember, dividend growth becomes constant from Year 3  onwards. P 0  = PV 0 Step 1:  Find P 2  i.e. PV 2  of all the constantly growing dividends one period before constant  growth commences: constant growth commences in Year 3, so using the  2
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Question  2      (cont.)     constant growth in dividends pricing formula gives us PV of the constantly growing dividends  at the end of Year 2 i.e. PV 2  or P 2 : 64 . 60 $ 02 . 0 2128 . 1 $ 10 . 0 12 . 0 2128 . 1 $ 3 2 = = - = - = g r D P e   Step 2:  Next, find PV 0  of D 1 , D 2 , and P 2  using PV of a single sum formula: PV = FV(1+r) -n    PV 0  = P 0  = $1.05(1+0.12) -1  + $1.1025(1+0.12) -2  + $60.64(1+0.12) -2   =  $0.9375 + $0.8789 + $48.34  =   $50.16   Question  3 Calculate the dividend yield for Lessitz Ltd, assuming that the required rate of return is 
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This note was uploaded on 04/24/2011 for the course BAFI 1012 taught by Professor Michaelgangemi during the Three '10 term at Royal Melbourne Institute of Technology.

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FF Qs & As Topic 3 Part 2 - FEEDBACKFORUM...

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