Home > Corporate Finance, Financial Accounting, Investment Analysis & Portfolio Management > VU Specialization Certification:Fall 2010 Subject FIN622 Corporate Finance Assignment 1

VU Specialization Certification:Fall 2010 Subject FIN622 Corporate Finance Assignment 1

Subject: FIN622 Corporate Finance

Assignment # 1:

ABC corporation stock is selling for Rs. 150 per share according to Karachi stock exchange market summary. A rumor about the company has been heard that the firm will make an exciting new product announcement next week. By studying the industry, it is being concluded that this new product will support a growth rate of 20% in dividend for two years. After that it is expected that the growth rate in dividend will decline to 6% and remains same onwards. The firm currently pays an annual dividend of Rs. 4.

The rate of return on stocks like ABC corporation is 10%.

Required:

  1. Find out the values for D1, D2 and D3
  2. What will be the price of stock (P2) at the end of year 2?
  3. What will be the present value (P0) of stock?
  4. Should we buy stocks of ABC Corporation at Rs. 150?

Solution:

Data Available;

Market selling price of share= Rs. 150

g=20% (for 2 years)

g= 6% (for 3rd year and so on for 4th , 5th etc)

r=10%

D0= Rs. 4

D0=Rs. 4 P2=?
0 1 2 3 4 5
g=20%
r=10%
g=20%
r=10%
g=6%
r=10%
g=6%
r=10%
g=6%
r=10%
g=6%
r=10%

Part 1:

D1= D0 * (1+g) => 4 * (1.20) => 4.8

D2= D0 * (1+g)2 => 4 * (1.20)2 => 5.76

D3 = D0 * (1+g)3 => 4 * (1.06)3 => 1.76

Part 2:

P2= (D2(1+g))/(r-g) => (5.76(1.06))/(0.10-0.06) => 6.11/0.04 => 152.75

Part 3:

P0=D1/(1+r) + D2/(1+r)2 + P2/(1+r)2

P0=4.8/(1.1) + 5.76/(1.1)2 + 152.75/(1.1)2

P0=4.8/(1.1) + 5.76/(1.21) + 152.75/(1.21)

P0=4.4 + 4.8 + 126.24

P0=135.44

Part 4:

Market selling price of share= Rs. 150 and

P0=135.44

Yes we have to buy the share of ABC Corporation, because selling price of share in market is greater than the PV.

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