Question

After all foreign and U.S. taxes, a U.S. corporation expects to receive 3 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $1.33 per pound, and the pound is expected to depreciate 3% against the dollar each year for an indefinite period. The dividend (in pounds) is expected to grow at 8% 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

Given dividend =pound 3

Hence in dollar terms =3*1.33=$4

Given growth rate of dividend =8%

Growth rate of pound =-3%

Hence growth rate of dividend adjusted to currency =

(1+ growth rate of dividend) *(1+growth rate of currency) - 1

=1.08*0.97-1

=1.0476-1

=4.76%

Hence growth rate =4.76%

Using the dividend discount model =

Price of share =dividend for next year /(cost of equity - growth rate)

=$4/(12%-4.76%)

=$4/7.24%

=55.2486

Since US parent hold =9 million shares

Hence value of US paren stake =9000000*55.2486

=497237400

(note: it is assumed that the dividend that parent expects is for next year)