Question

After all foreign and U.S. taxes, a U.S. corporation expects to receive 5 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $1.29 per pound, and the pound is expected to depreciate 7% against the dollar each year for an indefinite period. The dividend (in pounds) is expected to grow at 12% a year indefinitely. The parent U.S. corporation owns 9 million shares of the subsidiary. What is the present value in dollars of its equity ownership of the subsidiary? Assume a cost of equity capital of 12% for the subsidiary. Do not round intermediate calculations. Round your answer to the nearest dollar.

Answer 1

present value of perpetuity = first payment / (discount rate - growth rate)

present value in dollars of its equity ownership of the subsidiary = expected total dividend in dollars / (cost of capital - growth rate)

expected total dividend in dollars = expected dividend per share in pounds * exchange rate * number of shares owned

expected total dividend in dollars = 5 * 1.29 * 9,000,000 = $58,050,000

The  dividend (in pounds) is expected to grow at 12% a year indefinitely, and the pound is expected to depreciate 7% against the dollar each year indefinitely.

Net growth rate = growth rate in dividends - depreciation rate of pound against dollar

Net growth rate = 12% - 7% = 5%

present value in dollars of its equity ownership of the subsidiary = expected total dividend in dollars / (cost of capital - growth rate)

present value in dollars of its equity ownership of the subsidiary = $58,050,000 / (12% - 5%)

present value in dollars of its equity ownership of the subsidiary = $829,285,714