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)

Answer 1

(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