Question

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

a) Statement showing price of stock today

Year	Dividend	PVIF @ 10%	PV
1			0.9091	0.00
2			0.8264	0.00
3			0.7513	0.00
4		0.70	0.6830	0.48
5	0.70 x (0.70 x 25%)	0.88	0.6209	0.54
6	0.88 x (0.88 x 25%)	1.09	0.5645	0.62
7	1.09 x (1.09 x 25%)	1.37	0.5132	0.70
P7/Horizon Value		23.75	0.5132	12.19
Price of stock today	14.53

Thus current value of stock = $14.53

Horizon value = Dividend of year 8 / (required rate of return - growth rate)

Growth rate = 4%

Required rate of return = 10%

Dividend of year 8 = Dividend of year 7(1+ growth rate)

= 1.37(1+4%)

= 1.37(1+0.04)

= 1.37(1.04)

= 1.4248 $

Horizon value = 1.4248/10%-4%

= 1.4248/6%

= 23.75 $

b) Current value of preference shares = Dividend/Required rate of return

= 5 / 8%

= 62.5 $

c) Statement showing differences betwwen ordinary equity shares and preference shares

Ordinary equity shares	Preference shares
Ordinary equity shares givers ownership of the company	They do not give owenrship of the compsny
Dividend rate is not fixed	Dividend rate is fixed
In case of loss, Dividend are not paid to equity share holders	Incase of cummulative preference shares, in event of loss dividend on preference shares is accumulated and are paid when company makes profit

d) Three different forms of efficient market hypothesis

1) Strong Form : This form suggest that all information . i.e publicly available and private information is completely accounted in stock price

2) Semi - Strong Form : This form suggest that only publicly available information is accounted in stock price

3) Weak Form : This form suggested that stock price reflects all data of past prices