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Tut 4 - 15 March 2019: 4.1 (b)

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asked Mar 16 in BUS 1003H - Introduction to Financial Risk by MR S. MAHLATI (130 points)

For Tut 4 (15 Mar 2019)

4.1 (b)  shouldn't the solution be - 15.50 (1.07)(1/(1-Vj)) =R309.09 and not 15.50 (1/j) ?? (my working is based off VALUING EQUITIES Example 2 Lecture

1 Answer

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answered Mar 17 by Mufaro (540 points)

Hi. Here's the question we're working with, for clarity:

4.1 Use an interest rate of 13% p.a. and a dividend growth rate of 7% to calculate the present value of:

b. A share which just paid a dividend yesterday, which was R15.50.

The answer given is correct,  \(15.5 \times \frac1j \) 

The answer you've suggested would be the present value if you were receiving your next dividend tomorrow, i.e. you were going to be paid 15.5 x 1.07 tomorrow and then annually in perpetuity, increasing each year. If you multiply the answer you've suggested by \(v_i\), thereby discounting back a year, then you will get the correct answer.

To make this clearer, take a look at the cashflows or draw a timeline (always a good idea). Let's look at the cashflows here. Our last payment was 15.5  yesterday and our next payment is in a year's time. This payment would have grown by 7%. We have:

$$ PV = 15.5 \times 1.07 \times (v + 1.07v^2 + 1.07^2v^3 + ...) $$

$$ = 15.5 \times (1.07v + 1.07^2v^2 + 1.07^3v^3 + ...) $$

$$ = 15.5 \times a _\infty , [in \ arrears, \ at \ j]  $$

$$ =15.5 \times \frac1j$$

Where

$$ j = 1.13/1.07 -1 $$ 

commented Mar 27 by MR S. MAHLATI (130 points)

if the share is paying the dividend tomorrow or has paid it yesterday, what is the term for today? May you please show me the different Cashflow Diagrams for when a share/equity (increasing perpetuity) 

1. PAYS DIVIDEND IN 1 YEAR'S TIME

versus

2. PAYS DIVIDEND TOMORROW

AND

3. PAID DIVIDEND 1 YEAR AGO

versus

4. PAID DIVIDEND YESTERDAY


commented Mar 28 by Tanya (100 points)

Hi, I’ve attached a picture of the first two cash flows and I will attach the other one below it

commented Mar 28 by Tanya (100 points)

The second two cash flows

commented Mar 28 by Tanya (100 points)

My pictures were not uploaded, I sent them to Mufaro and he’ll send them.

commented Mar 28 by Mufaro (540 points)

Hi, I’ve attached a picture of the first two cash flows and I will attach the other one below it

image

commented Mar 28 by Mufaro (540 points)

The second two cash flows

image

...