Question

LUATION METHODS ESTION 1 a) It is now January 1, 2014. Last year ABC Company experienced major operational problems which affected the company's financial condition, forcing management to temporarily suspend dividend payments. It is expected that the company will not pay a dividend in 2014 and 2015 but will declare a dividend of K80 per share in 2016. Dividend growth is expected to be 10 percent in 2017 and 2018 and thereafter growth is expected to indefinitely be the same as for the economy, 8 percent. He required rate of return on the stock is 12 percent. (i) Calculate the expected dividends for 2014 through 2019. (ii) What is the value of the stock today? b) Six years ago ABC Corporation paid a K10 dividend and just paid a K13.40 dividend this year. Investors expect this growth rate to continue into the foreseeable future. Your required rate of return for investments in a firm as risky as ABC Corporation is 20 percent What is the value of one share of stock? () (ii) If the stock is selling for K110, should you buy it? Explain. diccounted in the market at 12 percent. The stock has I td.

Answer 1

Solution:

Q1. A)

It is given that the dividend will be zero in 2014, 2015 and K80 in 2016 and 10% increase in 2017 and 2018 and 8% growth after that .

i)

So dividend will be as follows

2014: 0

2015: 0

2016: K80

2017: 80 * (1+10%) = 88

2018: 88* ( 1+10%) = 96.8

2019 : 96.8 * (1+8%) = 104.544

ii)

In order to calculate the share price we need to find the terminal value after year 2018 and present value of all the dividends

Terminal value = Dividend *( 1+growth) / (required rate of return - growth ) = 96.8 * ( 1+8%) / ( 12% -8%) = 104.544/0.04 = 2613.6

Now we need to discount all the future dividends to get the share price

$Price = \frac{D1}{(1+r)^{1}}+\frac{D2}{(1+r)^{2}}+\frac{D3}{(1+r)^{3}} + \frac{D4}{(1+r)^{4}}+\frac{D5}{(1+r)^{5}} + \frac{TV}{(1+r)^{5}}$

$Price = \frac{0}{(1+0.12)^{1}}+\frac{0}{(1+0.12)^{2}}+\frac{80}{(1+0.12)^{3}} + \frac{88}{(1+0.12)^{4}}+\frac{96.8}{(1+0.12)^{5}} + \frac{2613.6}{(1+0.12)^{5}}$

Price = 0+0+ 56.94+ 55.93 +54.93 + 1483.03= 1650.82

Part B )

In order to calculate the share price we need to find the growth rate .

Six years ago the dividend was 10 and currently it is 13.40

So,

CAGR = (ending value / starting value )^(1/years) - 1

CAGR =( 13.40/10)^(1/6) - 1 = 1.05-1 = 5%

Now we can use dividend discount model to find the share price

Price = D * ( 1 + g) / (r-g) = 13.40 * ( 1+0.05) / ( 0.20-0.05) = 14.07/0.15 = 93.8

I) share price is 93.8

ii) Stock is trading at 110 and calculate price is 93.8 and it is lower than the current price . Hence we will not buy the stock.