Question

In: Finance

a) ABC Ltd is not expected to pay any dividends for the next 3 years. Then...

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.

Solutions

Expert Solution

(a): Here D4 = $0.70, g = 25%. We can find D5, D6 and D7 by using the growth rate of 25%. D8 onwards growth rate will be 4%.

Thus current price = D4/(1+r)^4 + D5/(1+R)^5 + D6/(1+r)^6 + D7/(1+r)^7 + P7/(1+r)^7

Also P7 = D7*(1+g)/(r-g) = 1.3672*1.04/(.010-0.04) = 23.70

Thus current price = $14.50

Year (n) Dividend amount 1+r PV = amount/(1+r)^n
                   4 D4                                0.70              1.10                                       0.48
                   5 D5                                0.88                                       0.54
                   6 D6                                1.09                                       0.62
                   7 D7                           1.3672                                       0.70
                   7 P7                             23.70                                    12.16
Current price                                    14.50

(b): Current price of preference shares = perpetual dividends/discount rate = $5/8%

= $62.50

(c): The primary difference is that ordinary shares (also known as common shares) have a lower priority for company assets and only receive dividends at the discretion of the corporation's management. In other words holders of ordinary shares receive their share of capital only after holders of preference shares are paid in the event of winding up of the company. Also there are no voting rights provided to preference shareholders while ordinary shareholders get voting rights.

(d): There are 3 forms of efficient market hypothesis as explained below:

  • Weak efficient market hypothesis - In this form today's stock price reflects all data of past prices. Technical analysis will not be of any help here.
  • Strong efficient market hypothesis - In this form all types of information - public and even not public - is incorporated and reflected in today's price of the stocks. Investors cannnot beat the market.
  • Semi-strong efficient market hypothesis - In this form public information is part of a stock's current price and so technical and fundamental analysis are of no use.

Related Solutions

a) ABC Ltd is not expected to pay any dividends for the next 3 years. Then...
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...
a) ABC Ltd is not expected to pay any dividends for the next 3 years. Then...
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...
a) ABC Ltd is not expected to pay any dividends for the next 3 years. Then...
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...
ABC Ltd is not expected to pay any dividends for the next 3 years. Then the...
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. a) 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...
QUESTION START a) ABC Ltd is not expected to pay any dividends for the next 3...
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%,...
ABC company's ordinary shares are expected to pay $3 per share in dividends in 4 years...
ABC company's ordinary shares are expected to pay $3 per share in dividends in 4 years and after which the dividends are expected to grow at 2% annually forever. Company ABC's shares have a beta of 1.75. The long-term return of ASX200 is 9% and the return of T-bonds is 4% (a) What is the expected return of ABC's shares according to the CAPM? (b) What is the implied price per share? (c) If the shares are selling for $25/share,...
ABC company's ordinary shares are expected to pay $3 per share in dividends for 6 years...
ABC company's ordinary shares are expected to pay $3 per share in dividends for 6 years and after which the dividends are expected to grow at 2% annually forever. Company ABC's shares have a beta of 1.75. The long-term return of ASX200 is 9% and the market risk premium is 5%. (a) What is the expected return of ABC's shares according to the CAPM? (b) What is the implied price per share?
If Yumms Inc. is expected to pay dividends of $3.93 for the next seven years, and...
If Yumms Inc. is expected to pay dividends of $3.93 for the next seven years, and then after that the dividends are expected to grow at 1.8% thereafter. What would you be willing to pay for a share of stock if the required return is 3.8 percent? If the risk premium for large company stocks is currently 4%, and the T-Bill rate is 2.3%, then what is the current large company stock return?
2. Riordan Ltd. is expected to pay dividends in the next period (i.e. period 1) of...
2. Riordan Ltd. is expected to pay dividends in the next period (i.e. period 1) of 30% of its expected earnings per share of 40 cents. The company's dividends will then grow by 12% per annum in periods 2 and 3, and 10% per annum in periods 4,5 and 6, before settling down to a perpetual growth rate of 8% per annum. Required : (a) Calculate the maximum amount which you would be prepared to pay for a Riordan Ltd....
A stock will pay no dividends for the next 3 years. Four years from now, the...
A stock will pay no dividends for the next 3 years. Four years from now, the stock is expected to pay its first dividend in the amount of $2.1. It is expected to pay a dividend of $2.9 exactly five years from now. The dividend is expected to grow at a rate of 7% per year forever after that point. The required return on the stock is 12%. The stock's estimated price per share exactly TWO years from now, P2...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT