Question

Briefly discuss the relationship between the following: (Word limit 50-70 words) i. Share price and investors required rate of return ii. Share price and divided growth rate

b. Otama LTD has an issue of preference shares outstanding that pays a $2.85 divided every year. If this issue currently sells for $77.32 per share, what is the required return?

c. Price Tigers LTD expects to pay a $3.25 per share dividend next year. The company pledges to increase its dividend by 5.1% per year, indefinitely. If you require a return of 11% on your investment, how much will you pay for the company’s share?

Answer 1

Question a:

i) Share price and investors required return has inverse relationship.

If required return increases then share price will be decrease

If required return decrease then share price will be increase

Share price = Dividend / Required return

ii) Share price and dividend growh has positive relationship

If dividend growth increase share price increases

If dividend growth decrease share price decreases

Share Price = Dividend / (Required return - Growth rate)

Question b:

Dividend = D = $2.85

Share Price = P0 = $77.32

Required return = D / P0

= $2.85 / $77.32

= 0.0368598034

= 3.69%

Therefore, required return is 3.69%

Question c:

Expected dividend = D1 = $3.25

g = growth rate = 5.1%

r = required return = 11%

Share Price = D1 / (r-g)

= $3.25 / (11%-5.1%)

= $3.25 / 5.9%

= $55.0847458

Therefore, company's share price is $55.08