Question

External Byte is a recently listed company. The shareholders in this company have just received a dividend payment and they have been told that their next dividend payment will be $2.42. Investors expect this dividend to grow at constant rate of 1% pa thereafter. Assume that the required return for the investor is 17% pa.

a)Calculate the value of the company's share immediately after the dividend payment. Give your answer in dollars and cents to the nearest cent.

Value of share = $

Immediately after the dividends were paid, External Byte suddenly lost a key competitor who was involved in a huge corporate scandal. Investors believe that the resultant increase in market share will make the dividends grow faster than they initially predicted. They predict that the dividend growth will be increased to a constant rate of 8%.

b)Assuming the required return is the same as previously, calculate the increase in the value of the share caused by losing their key competitor. Give your answer in dollars and cents to the nearest cent.

Increase in value of share = $

Answer 1

Case 1: growth of dividend at 1%

D0=$2.42

D1=$2.42*(1+1%)=$2.4442

D2=($2.4442*(1+1%))=$2.468642

required return r=17%

Price =(D1/(1+r))+(D2/(r-g)/(1+r))

Terminal value=D2/r-g. This have to discounted to present value, that the resaon why we are dividing it with (1+r)

Price=((2.4442)/1.17)+((2.4686)/(17%-1%)/(1.17))

=2.089+((15.429)/(1.17))

=2.089+13.187

=$15.276

Case 2

growth rate to be at 8%

Price=D1/r-g

D1=$2.42*(1+8%)

=$2.6136

Price=$2.6136/(17%-8%)

=$2.6136/0.09

=$29.04

The increase in the share price caused by losing their competitor =$29.04-$15.276=$13.764

Share price icreased by 13 dollar 76 cents due to competitor collapse