Question

4. Consider the following three shares: a. Share A is expected to provide a dividend of $10 a share forever. b. Share B is expected to pay a dividend of $5 in one year. Thereafter, dividend growth is expected to be 4% a year forever. Share C is expected to pay no dividend in year 1, $35 per share in 2 years, $50 per share in 3 years, a dividend of $1 in year 4 and then expects the dividend to grow at 3% per annum indefinitely. c. If the required rate of return for each share is 10%, which share is the most valuable? Show your workings by calculating the value for all shares. (Correct to the nearest cent.) (7 marks)

Answer 1

4)
a)	Value of Share A (as per constant dividend model) = 10/10% =					$     100.00
b)	Value of Share B (as per constant dividend growth model) = 5/4% =					$     125.00
c)	Vslue of Share C is to be falculated as below:
	Year	Dividend	PVIF at 10%	PV at 10%
	1	0	0.90909	$                 -
	2	35	0.82645	$          28.93
	3	50	0.75131	$          37.57
	4	1	0.68301	$            0.68
	PV of dividends t1 to t4 =			$          67.17
	Continuing value of dividends = 4*1.03/(0.10-0.03) =				$          58.86
	PV of continuing value = 58.86*0.68301 =				$          40.20
	Value of share C				$          99.06
	ANSWER:
	SHARE B IS THE MOST VALUABLE SHARE.