ACCA Strategic Professional · Advanced Financial Management · Valuation for acquisitions and mergers
Dalmar plc has a cost of equity of 11%. It has just paid a dividend of $1.00 per share. Dividends are forecast to grow at 10% a year for the next two years, and then at 4% a year indefinitely. Which of the following is the closest estimate of the current ex-dividend share price?
The estimate is about $17.9, found by discounting D1 and D2 and adding the year-2 terminal value of 1.2584/0.07 = 17.98. The closest listed option is $17.82.
- A$16.63Correct
- B$15.73
- C$17.82
- D$14.29
Explanation
D1 = 1.10, D2 = 1.21, D3 = 1.21 x 1.04 = 1.2584. Value at end of year 2 = 1.2584/(0.11-0.04) = 17.977. PV = 1.10/1.11 + (1.21+17.977)/1.1321 = 0.991 + 16.948 = $17.94. This does not match any option precisely, so the closest listed is $17.82.
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