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CA Final · Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Advanced Financial Management

Case: Kaveri Textiles Ltd expects a dividend of Rs 6 per share next year (D1). Dividends are expected to grow at a constant 5% a year indefinitely. Investors in similar-risk shares require a return of 11%. The company's shares currently trade at Rs 90 in the market. What is the intrinsic value per share using the constant growth model, and what is the implication?

The constant growth model gives intrinsic value as next year's dividend divided by required return minus growth, which is 6 divided by 6%, or Rs 100. Since the market price of Rs 90 is lower than this value, the share is undervalued and appears worth buying.

  1. ARs 100; the share is undervaluedCorrect
  2. BRs 54.55; the share is overvalued
  3. CRs 105; the share is undervalued
  4. DRs 100; the share is overvalued

Explanation

Intrinsic value = D1/(ke - g) = 6/(0.11 - 0.05) = 6/0.06 = Rs 100. Check: 100 x 0.06 = 6. Market price Rs 90 is below Rs 100, so the share is undervalued. Rs 105 comes from using D1 x (1+g) in the numerator (6.30/0.06), which is wrong because Rs 6 is already next year's dividend.

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