Question

a) Shengyuan Company has just paid a cash dividend of 20 cents per share. Investors require a 16% return from investments such as this. If the dividend is expected to grow at a steady rate of 4% per year, what is the current value of the share? What will the share be worth in five years?  Show working out.

                                                                                                            

b) Drongo Corporation is considering an investment with a payback of five years and a cost of $12000.  If the required return is 8%, what is the worst-case NPV? Explain.  Show working out.          

                                                                                                               

Answer 1

a]	Current value of the share [per the constant dividend growth model] = D0*(1+g)/(r-g)
	where,
	D0 = last dividend
	r = required return
	g = growth rate in dividends
	Therefore,
	Current value of the share = 0.20*1.04/(0.16-0.04) =	$         1.73
	Value of the share after five years = D6 [expected dividend for the 6th year]/(r-g) = 0.20*1.04^6/(0.16-0.04) =	$         2.11

b]	Annual cashflow = Initial investment/Payback period = 12000/5 =	$                2,400
	Worst case NPV = -12000+2400*(1.08^5-1)/(0.08*1.08^5) =	$             (2,417)

Part [b] There are no details as to base/best/worst case parameters. Hence, the worst case has

been considered as when the project life ends at the end of the year.