Question

a) ABC Ltd is not expected to pay any dividends for the next 3 years. Then the expected dividend is $0.60 per share, which will continue to grow at a constant rate of 25% per annum for another 3 years. After that, the dividend will grow indefinitely at 4% per annum. If the rate of return is 11% per annum, what is the current value of a share in ABC Ltd?

b) If the discount rate is 8%, what is the current value of a preference share with $5 dividends perpetually?

c) Describe three differences between ordinary shares and preference shares.

d) Describe three different forms of efficient market hypothesis.

Please show all working

Answer 1

Answer(b):

Value of preference share = Dividend / Discount rate

Value of preference share: 5 / .08 = $62.50

Answer(c):

Differences between ordinary shares and preference shares-

1. Ordinary shares do not get preference in payment of dividend while preference shares get preference in payment of dividend with a fixed percentage.
2. Ordinary shareholders are the owner of the company and they also have voting rights, they can vote in company's Annual general meeting while preference shareholders are the owner and also do not have any voting rights.
3. At the time of liquidation, ordinary shareholders get the capital repayment at the end, after repaying back to bondholders, creditors and preference shareholders so preference shareholders get preference in capital repayment after creditors but ordinary shareholders do not have any such preference.

Answer(d):

Efficient market hypothesis- This theory states that share price reflect all the necessary information. It also states that stocks trade at the fair market value.

Three different forms of efficient market hypothesis- Are as following:

Weak form- It suggests that stock price today reflects all the past information so no technical analysis will work as there is no pattern exist only fundamental analysis can work to some extent but fundamental analysis also does not provide long term advantage.

Semi strong form- It says that new information is already priced in to security so neither fundamental nor technical analysis work because investors cannot utilize these analysis to gain higher returns.

Strong form- It says that no information can give advantage to the investors, they cannot earn higher returns, both private and public information is priced in to the security prices. No investor can beat the market and they cannot earn above the normal returns.