ExpertHard2 marksMultiple Choice
ACCA · Question 12 · Business Valuations
'VertiFarm PLC', a vertical farming company, has just paid a dividend of 20 cents per share. Dividends are expected to grow at 10% for the next year, and then at a constant rate of 4% per annum in perpetuity. The cost of equity is 12%.
Using the Dividend Valuation Model, what is the current ex-dividend share price of VertiFarm PLC?
'VertiFarm PLC', a vertical farming company, has just paid a dividend of 20 cents per share. Dividends are expected to grow at 10% for the next year, and then at a constant rate of 4% per annum in perpetuity. The cost of equity is 12%.
Using the Dividend Valuation Model, what is the current ex-dividend share price of VertiFarm PLC?
Answer options:
A.
$2.50
B.
$2.60
C.
$2.75
D.
$3.00
How to approach this question
Calculate the dividend for Year 1 (D1) using the 10% growth rate. Then apply the standard DVM formula P0 = D1 / (Ke - g) using the long-term 4% growth rate.
Full Answer
C.$2.75✓ Correct
The dividend just paid (D0) is 20 cents.
The dividend expected in one year (D1) will grow by 10%: D1 = 20 × 1.10 = 22 cents.
From Year 1 onwards, the growth rate (g) is a constant 4%.
The DVM formula is P0 = D1 / (Ke - g).
P0 = 22 / (0.12 - 0.04) = 22 / 0.08 = 275 cents, or $2.75.
Common mistakes
Using D0 instead of D1 in the numerator, or applying the 10% growth rate into perpetuity.
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