Question

A dividend of £800,000 has just been paid. The company expects that this dividend will increase to £850,000 next year and continue to grow at this rate for the following four years (years 2-5). In year 6, it is expected that the growth rate will fall to 4% because of company investment plans. Cowtop Farm has 1.5 million £1 authorised shares of which 1 million have been issued. Shareholders expect a return of 12% on their investment.

Q: Calculate the share price assuming that the dividend is expected to grow by 6.25% per annum for the foreseeable future.

Answer 1

Answer: -

price per share =£14.78

Explanation: -

Information given

Dividend paid (D0)= £800,000

Growth rate = 6.25%

Expected return = 12%

number of shares outstanding = 1,000,000

Step 1: calculation of dividend per share

Dividend per share = £800,000 / 1,000,000

= £.8 per share

Step 2: calculation of price per share

the equation for the Expected return using Gordon constant growth model is:

Ks = D1 / P0 +g

Where,

Ks =Expected return of share holders

D1= Dividend per share at time 1

P0=market price per share at time 0

g = expected dividend growth rate

By rearranging the equation, we get,

P0 = = D1 / (Ks- g)

Here,

Ks = 12%

D1 = D0 * (1+groeth rate)

= .8 *(1.0625)

= £.85

P0=?

g = 6.25%

By substituting the values, we get,

P0 = .85 / (12%-6.25%)

P0 = .85 / .0575

P0 = £14.78