MFIN601 WEEK 1 Revision SOLUTIONS

Solution 1

Solution Q2
Step 1: Calculate the required rate of return on the stock:

Step 2: Calculate the PV of the expected dividends:

D0 = $2.00.

D1 = $2.00(1.20) = $2.40.

D2 = $2.00(1.20)2 = $2.88.

D3 = $2.88(1.07) = $3.08.

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MFIN601 WEEK 1 Revision SOLUTIONS

Step 3: Calculate the PV of the expected dividends:

Step 4: Calculate
P^ 2 or terminal value:

Step 5: Calculate the PV of

P^ 2 :

[Note: When done in Excel this equals $46.10 see below in Q3)

Step 6: Sum the PVs to obtain the stock’s price:

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MFIN601 WEEK 1 Revision SOLUTIONS

Solution Q3

Part (a)

Part (b)

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MFIN601 WEEK 1 Revision SOLUTIONS

Solution Q4
Step 1: Calculate the dividends of the initial phase of variable growth rates:

D0 0.00
D1 0.00
D2 0.00
D3 1.00
D4 1.50 =1 x 1.5
D5 2.25 =1 x 1.52
D6 2.43 =1 x 1.52 x 1.08

Step 2: Discount dividends 1 to 5 only back to present values and sum them:

t D (1 + rE)t PV of D
0 D0 0.00 1 0
1 D1 0.00 1.15 0
2 D2 0.00 1.3225 0
3 D3 1.00 1.520875 0.657516
4 D4 1.50 1.749006 0.85763
5 D5 2.25 2.011357 1.118648
SUM = 2.633794

Step 3: find the value of share price at the end of period 5 at the start of the normal growth phase
(Dividend s from period 6 till eternity):

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MFIN601 WEEK 1 Revision SOLUTIONS

Step 4: find the present value of the share price at the end of period 5:

Step 5: Add up present values to get intrinsic value of share today:

17.25914
2.633794
19.89293

$19.89 rounded