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Tutorial 5 Questions

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Uploaded by

Thảo Ngân Nguyễn
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© © All Rights Reserved
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FINM 2412 Financial Management for Business

Tutorial 5 Questions

Question 1

Raytheon Company pays $2.87 in dividends per share. If its cost of equity is 4.5% and its dividend
growth rate is 3%, use the constant dividend growth model to work out the price.

What would happen if its dividend growth rate went up to 4%?

Currently Raytheon trades at $206.8 on the NYSE. Calculate its dividend yield and work out the
implied cost of equity if the dividend growth rate is expected at 3%.

Question 2

The required rate of return on the shares in the companies identified in (a) to (c) below is 15% p.a.
Estimate the correct share price in each case. Assume that all companies pay one dividend per year.

a) The most-recent dividend (paid yesterday) of Alpha Ltd. is $1.50. The company expects the
dividend to remain constant for the foreseeable future.
b) Beta Ltd.’s current dividend per share is 80 cents (paid yesterday). This dividend is expected
to grow at a constant rate of 5% p.a. forever.
c) Gamma Ltd.’s current dividend per share is 60 cents (paid yesterday). The dividend of the
company has been growing at 12% p.a. in recent years, a rate expected to be maintained for
a further 3 years. It is then envisaged that the growth rate will decline to 5% p.a. and remain
at that level indefinitely.

nb: valuing a share is not unlike valuing a bond – share value is the present value of expected future
cashflows. In the case of a share, we require estimates of all future dividends, their timing, and the
appropriate discount rate (the required rate of return). Past dividends (including those ‘paid
yesterday’) are irrelevant. The most-recent dividend is given in this question because, when coupled
with the dividend growth rate, we can calculate the expected future dividends.

Question 3

Oakley International pays annual dividends on its ordinary shares. The latest dividend of 75 cents per
share was paid yesterday. The dividends are expected to grow at 8% p.a. for the next two years,
after which a growth rate of 4% p.a. is expected to be maintained indefinitely. Estimate the value of
one share if the required rate of return is 14% p.a.

Question 4

If each of two stocks are currently paying an annual dividend of $1 per share (i.e., their last dividend
was $1), but the dividends of Stock B are expected to grow at twice the 4% p.a. rate anticipated for
Stock A, then Stock B would currently sell for twice the price of Stock A. True or false? Explain.
Investors require a return of 10% p.a. on both A and B.

1
Question 5

The common stock of Omega Ltd. is selling on the market for $32.84. The company has just paid an
annual dividend of $2.94 per share and dividends are projected to grow at 9.5% p.a. If you purchase
the stock at the current market price, what is the expected rate of return?

Question 6

Most of the lecture examples value shares using discounted dividend valuation models that assume
an annual dividend. In practice, firms tend to pay dividends twice a year – an interim and a final
dividend. This question illustrates how one might approach valuation in such circumstances.

Assume today is 1st January. Lorem Ipsum pays an interim dividend on 30 April each year and a final
dividend on 31 October each year. Last year’s interim and final dividends were 40 cents and 1.20
respectively. Lorem Ipsum has recently been achieving growth rates of 4% on both of these
dividends.

 Assume that the 4% dividend growth will continue indefinitely. Lorem Ipsum’s required rate
of return on equity is 12% per annum. Estimate the correct share price of Lorem Ipsum as at
today (1st January).

 As an alternative to worrying about separate interim and final dividends, we might just add
them together and treat it as a single annual dividend. Last year, Lorem Ipsum paid a total of
$1.60 in dividends. Since a large proportion of this was paid on 31 October, let’s proceed as
if $1.60 was paid on 31 October. Again, assume that this dividend will grow at 4% p.a.
indefinitely. Estimate the correct share price as at today (1st January). How different is the
price to the estimate in part a)?

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