Question

In: Finance

1. ABC Limited will pay a $2.76 dividend next year (t=1) on its ordinary shares. The...

1. ABC Limited will pay a $2.76 dividend next year (t=1) on its ordinary shares. The shares are currently selling at $64.01 per share. What is the market's required return on this investment if the dividend is expected to grow at 3% forever? (as a percentage to nearest two decimal places; don't use % sign)

2. You are interested in investing in a company that expects to grow steadily at an annual rate of 2 percent for the foreseeable future. The company just paid a dividend of $4.58. If your required rate of return is 16 percent p.a., what is the most you would be willing to pay for this share? (Round to the nearest cent; don't use $ sign.)

3. A company has just paid its annual dividend of $4.55 yesterday, and it is unlikely to change the amount paid out in future years. If the required rate of return is 14 percent p.a., what is the share worth today? (to the nearest cent; don’t include $ sign)

Solutions

Expert Solution

Solution to QUESTION-1

Here, we’ve Dividend per share (D1) = $2.76 per share

Current market price per share (P0) = $64.01 per share

Dividend growth rate (g) = 3.00% per year

Under Constant-growth dividend discount model, the market's required return on this investment (Ke) is calculated by using the following formula

Market's required return on this investment (Ke) = [D1 / P0] + g

= [$2.76 / $64.01] + 0.03

= 0.0431 + 0.03

= 0.0731 or

= 7.31%

“Hence, the Market's required return on this investment (Ke) will be 7.31%”

Solution to QUESTION-2

Here, we’ve Dividend in next year (D0) = $4.58 per share

Dividend Growth Rate (g) = 2.00%

Required Rate of Return (Ke) = 16.00%

Therefore, the Price of the stock using Constant Dividend Growth Model = D0(1 + g) / (Ke – g)

= $4.58(1 + 0.02) / (0.16 – 0.02)

= $4.6716 / 0.14

= $33.37 per share

“Hence, the price that would be willing to pay for this share will be $33.37”

Solution to QUESTION-3

Price of the Share today = Annual dividend per share / Required rate of return

= $4.55 per share / 0.14

= $32.50 per share


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