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I dont get working for this question

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asked Mar 14 in BUS 1003H - Introduction to Financial Risk by Tintswalo (130 points)

Example 2.20

Consider a share that will pay dividends at the end of each year with a dividend of R5 due in one year's time. The dividends are expected to increase by 3%p.a.(after the dividend due in a year) and the share price is expected to be R113 In 10 years time. You want to buy the share now. How much would you pay for the share using an interest rate of 16% p.a.... the price in the solution includes 113v^10@ 16%.... I had thought that the 113 would be discounted for 10 years @16% and compared to the present value of the equity to determine how much I should be willing to pay. I dont understand why 113v^10 is a part of the present value.

1 Answer

+1 vote
answered Mar 15 by Connor (360 points)

Equities are valued as if you plan to hold them forever (perpetuity) and therefore priced such that you receive all of the future dividends from that point onward. This means that all the future dividends are present valued. 

The R113 in 10 years time is the price of all the future dividends from that point onward. Therefore, the R113 discounted to time 0 together with the present value of the dividends up to time 10 will give you the total present value of the share.

Hope this helps!




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