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Financial Management, 2e
FINANCIAL MANAGEMENT 2e
Rs 4.00
8.00%
14.00%
D o (1 + g)
r-g
(1+ g)8 =
D8 3
= =3
D1 1
g = 0.1472 = 14.72%
Current dividend, D0
Growth in dividend, g
Required return, r
Rs 3.00
14.72%
20.00%
Page 1 of 5
Financial Management, 2e
FINANCIAL MANAGEMENT 2e
Solution:
The return expected by the market can be arrived using DDM for stock value as
below:
D o(1+ g)
r-g
D
r-g= 1
P0
r=
D1
+g
P0
Current dividend, D0
Growth in dividend, g
Current Market Price, P0
Expected dividend next year, D1 = D0 (1+g) =
Required Return, r = D1/P0 + g
= 2.75/50 + 0.10 =
15.500%
Page 2 of 5
Rs 2.50
10.00%
Rs 50.00
Rs 2.75
Financial Management, 2e
FINANCIAL MANAGEMENT 2e
Solution:
Current dividend
Rs 2.00
Growth rate for 4 years
15%
Required rate of return
16%
Present value of dividends for next four years:
1
2
Year
2.65
2.30
Dividend, Rs
PV at 20%, Rs
1.98
1.97
PV of Dividends from Year 1 - 4
3
3.04
1.95
Page 3 of 5
4
3.50
1.93
7.83
6%
Rs 3.71
Rs 37.08
Rs 20.48
Rs 28.31
Financial Management, 2e
FINANCIAL MANAGEMENT 2e
Solution:
Under the present scenario the stock price is Rs 72.00 as worked out below:
Current dividend, D0
Growth in dividend, g
Required return, r
Rs 4.00
8.00%
14.00%
D o (1 + g)
r-g
Page 4 of 5
Financial Management, 2e
FINANCIAL MANAGEMENT 2e
Solution:
The dividend discount model in terms of earnings and retention ratio is
Price, P0 =
D1
E x (1 b)
= 1
(r g)
(r g)
Current Earnings, E0
Rs 4.00
Growth Rate, g
7.50%
Required Return, r
14.00%
Expected Earnings, E1
Rs 4.30
Retention Ratio, b
40.00%
Price = 4 x (1+ 0.075) x (1 - 0.4) / (0.14 - 0.075)
= Rs 39.69
9.92
The PE multiple is = 39.69/4.00 =
Solution:
The price in terms of earnings and retention is Rs 35.67 as shown below:
Current Earnings, E0
Rs 4.04
Growth Rate, g
3.00%
Required Return, r
0.1
Expected Earnings, E1
Rs 4.16
Retention Ratio, b
40%
Price = 4.04 x (1+ 0.03) x (1 - 0.4) / (0.1 - 0.03)
= Rs 35.67
The PE multiple of ABC Corporation = P/E = 35.67/4.04 = 8.83
With revised and increased estimates of growth the PE multiple would rise.
Current Earnings, E0
Rs 4.04
Growth Rate, g
6.00%
Required Return, r
10%
Expected Earnings, E1
Rs 4.28
Retention Ratio, b
40%
Price = 4.04 x (1+ 0.06) x (1 - 0.4) / (0.1 - 0.06)
= Rs 64.24
The PE multiple of ABC Corporation = P/E = 64.24/4.04 = 15.90
Page 5 of 5