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CMA Final · Strategic Financial Management · Equity and Bond Valuation and Evaluation of Performance

Meridian Textiles Ltd expects to pay a dividend of Rs 6 per share next year. Dividends are expected to grow at a constant 5% per year indefinitely, and investors require a return of 12%. What is the intrinsic value per share under the constant growth model?

The intrinsic value is Rs 85.71 per share. Using the constant growth model, next year's dividend of Rs 6 is divided by the difference between the required return of 12% and the growth rate of 5%, that is 7%, which gives Rs 85.71.

  1. ARs 50.00
  2. BRs 85.71Correct
  3. CRs 100.00
  4. DRs 52.50

Explanation

Under the Gordon model, P0 = D1/(ke - g) = 6/(0.12 - 0.05) = 6/0.07 = Rs 85.71. Rs 50 results from dividing by ke alone (6/0.12). Rs 100 results from using a 6% spread, which is wrong. Rs 52.50 is not derived from the given data.

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