Question

QUESTION START

a) ABC Ltd is not expected to pay any dividends for the next 3 years. Then the expected dividend is $0.70 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 10% 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? (1 mark)

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

d) Describe three different forms of efficient market hypothesis.

Answer 1

Current Value of Share = Present Value of all dividends received till 6 years + Present Value of the Share value at the end of 6 th year

Present Value of all dividends received till 6 years

For first three years dividend is nil, and then 0.70 per share with a growth of 25% for three years, with discount rate of 10%

Year	Dividend	PVF	PV
1	0	0.9091	0.00
2	0	0.8264	0.00
3	0	0.7513	0.00
4	0.7	0.6830	0.48
5	0.88	0.6209	0.54
6	1.09	0.5645	0.62
		Total	1.64

So Present Value = $ 1.64

Similarly Presnt value of Share price = P6 * PVF(10%,6) = 18.96*0.5645 = 10.70148

P6 = D6(1+4%)/Ke-g = 1.09(1.04)/0.10-0.04) = $ 18.96

So Current value of Share at year 0 =10.70148+ $ 1.64 = $ 12.34

b. Current value of preference share with perpetuity = DIvidend recived / rate of discount

= 5 / 8% = $ 62.5

C. Preference shares are those shares which have the preference over common stock (ordinary shares) while payment of dividend or repayment of capital in the event of liquidation.

d. The three form of efficient market hypothesis are Weak form (public haave only historical information), Semi Storong Information (Investors have only publicly availabel inforation) and Strong form of efficieny (investor has all information).