Page 284 - AFM Integrated Workbook STUDENT S18-J19

Chapter 13

Question 3

Corfu Co has been paying an annual dividend per share of $0.25 for the last
few years. The most recent dividend has just been paid.

The directors intend to continue the constant dividend policy for two more
years, and then to increase the dividend by 3% per year thereafter.

The shareholders’ required rate of return is 10%.

Required:

Estimate the value of each Corfu Co share, using the dividend valuation
model.

Solution

DVM theory: The value of a share is the present value of the expected future
dividends discounted at the shareholders’ required rate of return.

i.e. [$0.25 × 2 year annuity factor at 10%]

+ [ 0.25(1.03) × 2 year discount factor at 10%]
0.10 – 0.03

= (0.25 × 1.736) + (3.68 × 0.826)

= $3.47

Illustrations and further practice

Now try TYU 3 in Chapter 13

272