Question

Company B: B is an unquoted shoe manufacturer. It has also suffered in the recent recession but the directors are confident that the company is past the worst and growth lies ahead:

- Earnings are expected to be 12.5 million € next year and expected to grow at 2% p.a.

- Dividends will be 5 million € for each of the next three years and then expected to grow at 3% thereafter.

Daniels has located a similar listed company that has an earnings yield of 12% and a cost of equity of 14%.

Calculate the value of Company B using the dividend valuation model:

Select one:

a. 42.3 m €

b. 43.2 m €

c. 46.8 m €

d. 47.3 m €

Answer 1

Option b

For valuing a company as per Dividend valuation the data regarding Earnings, growth rate of earnings and earnings yield have no effect.

In the given case the value of the company will be the present value of all future dividend payments.

In the case, dividend for year 1 to year 3 =Euro 5 million/ year

Present value of inflow= Sum of all Inflow / (1+discount rate)^n

where n= number of years

Hence, the present value of dividend of year 1 to 3 = Euro 5 million/ 1.14 + 5 million/(1.14)^2 +5 million/ (1.14)^3

= Euro (4.3860+3.8473+3.3749) million = Euro 11.6082 million

Dividend at year end 4=Dividend in year 3 *(1 +growth rate) = Euro 5 million *(1.03) =Euro 5.15 million

Value of all future dividends from year 4 at year end 3 = Dividend in year end 4/(Cost of equity-growth rate)

= Euro 5.15 million/(0.14-0.03) =Euro 46.8182 million

Value of the dividend from year end 4 now = Euro 46.8182 million/(1.14)^3 =Euro 31.6009

Hence, value of the company =Present value of all dividends = Euro(11.6082+31.6009) million =Euro 43.2 miilion.