Calculate the present value of both share: On 1st January 2018, you are looking
ID: 2821415 • Letter: C
Question
Calculate the present value of both share:
On 1st January 2018, you are looking for a share for possible inclusion in your investment portfolio. You have found two shares in the two different markets, Ordinary Share 1 in Market A and Ordinary Share 2 in Market B. Your analysis says that both share X and Y are highly positively correlated, so you are considering them as mutually exclusive. Your budget does not permit you to invest more than $90 for a share. The opportunity cost of your capital is 15%.
Ordinary Share 1 in Market A
The company’s incomes is growing at 11%. The dividend payment of $3.43 reflects such growth and same growth is expected to continue in the foreseeable future.
31st December of
Annual dividend payments
2018
$3.43
Ordinary Share 2 in Market B
The expected dividend payments of the Ordinary share are given in the following table. It pays $7 in 2016, $5 in 2017. Then remains same at $6 per year for following years (2018 to 2022), before picking up the momentum of 10% growth in 2023. This growth rate reflected in 2023’s dividend is expected to remain same in the foreseeable future.
31st December of
Annual dividend payments
2016
$7.00
2017
$5.00
2018
$6.00
2019
$6.00
2020
$6.00
2021
$6.00
2022
$6.00
2023
$6.60
2024
$7.26
2025
$7.99
31st December of
Annual dividend payments
2018
$3.43
Explanation / Answer
A Dividend next year 3.4 Growth rate 11% Cost of capital 15% Share price can be computed using Dividend growth model = Dividend next year/(cost of capital - growth rate) =3.4/(15%-11%) 85.00 B we have dividend varying for intial few year there after growing at rate of 10% year 2018 2019 2020 2021 2022 i Dividend 6.0 6.0 6.0 6.0 6.0 ii Terminal value (refer note 1) 132.0 iii=i+ii Total 6.00 6.00 6.00 6.00 138.00 iv PVIF 0.8696 0.7561 0.6575 0.5718 0.4972 v=iv*iii Present value 5.22 4.54 3.95 3.43 68.61 85.74 Note - 1 Terminal value at the end of year 2022 = Dividend next year/(cost of capital - growth rate) =6.6/(15%-10%) 132 Hence, both stock has price lower than $90 A price = 85.00 B price = 85.74
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