Question

QUESTION START

a) Using the Dividend Discount Model (DDM), you estimate the intrinsic value of ABC Ltd is $7.50. If the constant dividend growth rate is 5% and the required rate of return is 9% per annum. Calculate the dividend per share paid by ABC Ltd today.

b) ABC Ltd just announced that it is not expected to pay any dividends for the next 4 years. Then the expected dividend per share found in part (a) will be paid to shareholders, which will continue to grow at a constant rate of 20% per annum for another 2 years. After that, the dividend will grow indefinitely at 5% per annum. If the rate of return is 9% per annum, what is the current value of a share in ABC Ltd?

c) Your friend purchased a preference share of ABC Ltd. If the discount rate is 7%, what is the current value of a preference share paying $3.10 dividends perpetually? (1 mark)

d) Explain the differences between primary market and secondary market.

e) “If the constant growth rate of dividend is zero, then the intrinsic value of a share decreases over time”. True or false? Explain.

Answer 1

Part A By DDM Price = D0 * (1 + g) / (Ke - g) 7.5 = D0 * (1 + 5%) / (9% - 5%) D0 = 0.286

Part B Calculate The price at end of Year 4 Price @ End of year 4 = =9.217 Price Today = 9.217 / 1.09^4 =6.530

PART C Price of Preference Share = Dividend / (1+r) = 3.1 / 1.07 = 2.897

Part D Primary Market: It is a place where security is traded for the first time. Also known as new issue market. You can purchase directly from the company hence amount paid by investor goes to company. Eg IPO, FPO Secondary Market: It is a place where seurity already issued by company is traded.. Also known as share market. You can purchase security from another investor hence amount paid by investor goes to another investor. Eg Share trading, derivative market.

PART E: False: Intrinsic Value is depended on cost of Equity (Expected return) so if the Ke decreases in future even if dividend growth rate is 0. Price will increase. Suppose D = 10, Ke = 10% Therefore IV = 10 / 10% = 100 Next year when D remain same 10, Ke reduces to 9% IV = 10 / 9% = 111.11