Question

(b) Suppose a Spanish investor is considering the following investments: Investment A: This is the ordinary share of a matured company. The market price for this security is €40 per share. The company is expected to pay €4 dividend per share one year from now and its expected growth rate for foreseeable future is 4%. Investment B: This is the ordinary share of a fast-growing company. The market price for this security is €40 per share. The company expects to grow at a rate of 20% in the first two years and 10% for the following two years. Followed by this, the company is expected to settle to a constant growth rate of 5%. The company is expected to pay €5 dividend per share one year from now. Assume that the investor's required rate of return is 17% p.a. for both investments, Given the above information: Determine the value of both shares. (4 marks) ii. Based on the values determined in (i) and the indicated market prices, are these shares desirable for purchase? (2 marks)

Answer 1

ii) An investment that trades for more than the intrinsic value are called as overvalued stock and since in both the investments are overvalued hence are not recommended for buying.

ILANNER ♡ (1) Po= Di Ке- Po = current Price D = Dividend for the next year ke = cost of capital required tate of return g = growth rate of the from Investment A :- According to Que Po= €4 17% -4% = € 30.76 Investment B - According to Ques D = €5 K = 17% gi= 20 1 92 = 201. g3 = 10% 94-10% gn= 5% D2 = € 5 * 1.20 = 6€ Dz=€ 6 * 120 = 7. 2€ Du > €7.2* 1 to = 7.92€ DE = € 724 110-8-71€ • D6 = €8.71*1.05=9.14€ Rope Pro 9.14 € 76.23 17-05 Present value of these soolte o= €76.00 (1.175 REDMI NOTE 5 PRO €34.77 MI DUAL CAMERA Notes ОО