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IAI Actuarial Core Principles · Business Finance · Financial instruments issued or used by companies

A company expects a dividend of Rs 6 per share next year, growing at 5% a year indefinitely. Its shareholders require a return of 15%. Using the dividend growth model, what is the ex-dividend share value?

The share value is Rs 60, found by dividing next year's dividend of Rs 6 by the difference between the required return of 15% and growth of 5%. Ignoring growth would give Rs 40, which understates the value.

  1. ARs 40
  2. BRs 42
  3. CRs 60Correct
  4. DRs 120
  5. Rs 30

Explanation

Value = D1/(ke - g) = 6/(0.15 - 0.05) = Rs 60. Rs 40 uses 6/0.15, ignoring growth. Rs 42 would arise from wrongly applying 6 x 1.05 /0.15.

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