Question

(1)A company’s shares have just paid a dividend of 5 pence per share. The market expects dividends to grow annually at a rate of 3%, and requires a return on the shares of 7%per annum. At what price will the shares be trading?(£1.2875)

(2)As (1), but dividends are expected to grow at 6% per annum for the next 3 years (so the t= 1dividend will be 5.3 pence etc.) and then remain at that level in perpetuity.

Answer 1

using (1) This can be solved perpetunity formula growth Price - Do ( 1+g] Ke-9 where Do = Current year's dividend ke= required return g = growth rate Price - 5 [1+ 3%. 7% - 31 = 5.15 = 128.75 pence de £ 1.2855 dividend at t = 5+6% = 5.3 rol ta = 5.3 + 6% = 5.618 (22] tz = 5.618+ 6% = 5.95508 [3] dividends will remain at 5.95508 pence in perpetuity Continuous value = D3 5.95508 -85-0196 7/ Ке share price is present price is present value of all above - discount rate = 7%. 5.3 5.618 (5.95508 +85.0796) + resent value] 1.07 (1.07a (1.073 dividendo share price = 5.3

- 4.9533 + 4.9070 + 74.3057 = 84.166 pence of £0.84166 NOTE: There is no growth in dividend after year 3 as per question so we have taken formula as D3 If there is Continuous growth even after year 3 The formula would be D3 ke-g ke