Question

Question

A. The value of ordinary shares cannot be tied to the present value of future dividends because

most companies don’t pay dividends. Comment on the validity, or lack thereof, of this statement.

B. Martin King is analysing the shares of MIA Radiology. MIA’s equity pays a dividend once each year, and it just distributed this year’s $0.85 dividend. The market price of the share is $12.14. Martin estimates that MIA will increase its dividends by 7 % per year forever. After contemplating the risk of MIA’s equity, Martin is willing to hold the shares only if they provide an annual expected return of at least 13 %. Should she buy MIA shares or not?

Answer 1

A: I agree with the statement because most of the company’s may not pay a dividend but they will still have good potential for growth. Valuation of the company on the basis of free cash flows generated by it is hence a better method for valuation. This is because a company may have high free cash flows but may not distribute them as dividends, rather they may retain the free cash flows for investment in future projects. Hence the company should be valued on the bases of present values of free cash flows rather than dividends.

B: Share price = D1/( k- g)

= 0.85*107%/ (13%-7%)

=15.16

The current market price is lower than the intrinsic value and hence the shares should be purchased.