Question

(c) For a rapidly growing Japanese company, the growth rate is projected to be 20% for the next two years and 10% for the following year. At the end of 3 years, the growth rate is expected to settle to 5% and remain so for the foreseeable future. The company has recently paid a dividend of ¥220 per share. Assume that the investors' required rate of return for the company's shares is 17%. i. Determine the value of this company's share. [3 marks] ii. If the market price of the share is ¥2,500 per share, is the share a desirable purchase? Explain. [1 mark]

Answer 1

i). Value of company's share = [{D0*(1 + g1)} / (1 + r)] + [{D0*(1 + g1)*(1 + g2)} / (1 + r)²] + [{D0*(1 + g1)*(1 + g2)*(1 + gC)} / {(r - gC)*(1 + r)²}]

= [{220 * (1 + 0.20)} / (1 + 0.17)] + [{220 * (1 + 0.20)*(1 + 0.10)} / (1 + 0.17)²] + [{220 * (1 + 0.20)*(1 + 0.10)*(1 + 0.05)} / {(0.17 - 0.05)*(1 + 0.17)²}]

= 225.64 + 212.14 + 1,856.23 = ¥2,294.02

ii). If the market price of the share is more than the value of company's share then it is not a desirable purchase.