Question

4. A Company has just paid a dividend of 100 euros today (beginning of period 1). This company is at a mature stage and has a ROE of 10% and a payout ratio of 50%. The required return of the shareholders is rE=25%. It is estimated that the share can be sold at the end of the period (period 1) at a price equal to P1=1,210 euros, right after the dividend D1 of that period has been paid. What is the maximum Price that the shareholder would be willing to pay for this share today (beginning of period 1). Show work.

a) 1,052 euro

b) 6,051.25 euro

c) 1,100 euro

d) None of the above

Answer 1

To calculate the price of share we use M&M approach.

But before this we nnet to calculate D1 and P1 before dividend

D0 = Current year dividend = 100 euros

payout ratio = 50%

So,

D0 = EPS x Payout ratio

100 euros = EPS x 50%

EPS = 200 euros

Nex year EPS = Current Year EPS + Current Retain earning x ROE = 100 euros + 100 euros x 10% = 210 euros

or we can find it by growth

g = ROE x Retantion earnig = 10% x 50% = 5% or say 0.05

D1 = D0 (1+g) = 100 euros (1+0.05) = 105 euros

Now P1 before dividend paid = P1 after dividend paid + Dividend = 1210 euros + 105 euros = 1315 euros

now we find current market price of share by using M&M approach.

Where:

P0 = Current Market Price

P1 = Next year market price before dividend paid

D1 = Next year dividend

ke = Required rate of return

Shareholder willing to pay maximum price of share today is 1,052 euros