Question

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 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

Value of Share = PV of CFs from it.

Div Calculation:

Year	Div	Formula	Calculation
4	$      0.70	Given	Given
5	$      0.88	D4(1+g)	0.7*1.25
6	$      1.09	D5(1+g)	0.88*1.25
7	$      1.37	D6(1+g)	1.09*1.25
8	$      1.42	D7(1+g)	1.37*1.04

P7 = D8 / [ Ke - g ]

P7 = Price after 7 Years

D8 = DIv after 8 Years

Ke = Required Ret

g = Growth Rate

P7 = D8 / [ Ke - g ]

= $ 1.42 / [ 10% - 4% ]

= $ 1.42 / 6%

= $ 23.70

Year	CF	PVF @10%	Disc CF
4	$      0.70	0.6830	$      0.48
5	$      0.88	0.6209	$      0.54
6	$      1.09	0.5645	$      0.62
7	$      1.37	0.5132	$      0.70
7	$   23.70	0.5132	$   12.16
Price of Share	$   14.50

Part B:

Price of Preference share = DIv/ Required Ret

= $ 5 / 8%

= $ 62.5

Part C:

Ordinary Share and Preference Share diff:

Preference share holders will have preferencial rights in payment of dividend and repayment of capital.

Ordinary share holders will have voting rights.