Problems For Class Questions: ABC Co.

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Problems for class discussion: week 2

1. ABC Co. has paid a dividend of $5 per share on September 4, 2013. The company pays its dividends each year on September 4 and the amount is expected grow at a rate of 10% per year for the next three years (i.e. the next three payments). Thereafter, the dividends will grow at a constant rate of 2% each year. The relevant discount rate for these cash flows is 12%.

(i) Find the price of a share of ABC on the following dates:
September 5, 2013
December 5, 2013
September 3, 2014
September 5, 2014
(ii) On September 6, 2013 ABC announced that it has found a promising investment opportunity such that it can invest $1 per share right away and have it earn a 20% return each year in perpetuity. The investment is annual and can be increased by 3% each year. The rate of return on the investment will remain at 20%/ What is the price of a share of ABC after the announcement?

Treat any time value implications for periods shorter than 4 days as negligible and ignore them in your calculations.

Guidelines:
(i) Solve for the price on September 5, 2013 and the one on September 5, 2014 first. Adjust each of these two prices as required to get the other two prices. Ask yourself: what changes when you go from Sep 5, 2013 to Dec 5, 2013 and from Sep 5, 2014 to Sep 3, 2014.

(ii) Use the standard NPVGO value approach. Using the DDM will be messier in this case.
************

Sep 5 2013 = 5.5/1.12 + 6.05/(1.12^2) + (6.655/(.12-.02))/(1.12^2) = 62.787
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