Question

Ebrahim corp pays an annual dividend of R3.50 per ordinary share.

The dividend is expected to grow at an annual rate of 8% for the

Next three years followed by 10% in the fourth year before it grows

At a constant rate of 5% from the fifth year of infinity. The company’s

Required return on similar investments is 15%. What is the value of each ordinary share in the company

Answer 1

Solution

Firstly, we will project dividend expectation for each year-

The following table summarizes the calculations:

Year	Growth rate	Dividend per share		Formula
Time 0		3.50
Year 1	8%	3.78		= 3.5 * (1 + 8%)
Year 2	8%	4.08		= 3.78 * (1 + 8%)
Year 3	8%	4.41		= 4.08 * (1+8%)
Year 4 Year 5	10% 5%	4.85 5.0925		= 4.41 * (1 + 10%) =4.85*(1+5%)

Dividend per share expected for each of the first 4 years must be discounted back to t=0 individually as follows:

Year	Growth rate	Dividend per share	PV at t=0	PV factor @ 15%
Year 1	8%	3.78	3.78*0.87=3.287	0.87
Year 2	8%	4.08	4.08*0.76=3.085	0.76
Year 3	8%	4.41	4.41*0.66=2.90	0.66
Year 4	10%	4.85	4.85*0.57=2.773	0.57

TOTAL PV at T=0 is 12.045

Year 5 onwards the growth rate of dividends is constant.

Using the Gordon growth model formula, we can arrive at the present value of perpetual dividends from the 5th year onwards at the start of the stable growth phase. This value is called the terminal value.

Terminal value = PV of perpetual dividends 5th year onwards =

P=D1/(R-G)​​ = 5.0925/(15% - 5%) = 50.925

Since the PV calculated above is at the end of the 4th year, it must be discounted back 4 years as follows:

PV at t=0 = 50.925/(1+15%)^4 = 29.12

Intrinsic Value of each share=PV of Dividends for the first 4 years + PV of terminal value

=12.045+29.12

=41.165