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Q&A Bank Q4.7

T

Tonym

Member
A potentially stupid question here, but it's been bugging me all evening.

Q4.7 in the Q&A bank is about valuing a company using the dividend model:

P = D /(i-g)

D=26
(i-g) is assumed to be 5%

The answer calculates the final value at as 26 / (0.8 x 0.05) and then multiplies this by 1.05 ^2 to get the value at 1/1/11

I understand the question and answer for the most part but can't figure out where the 0.8 comes from. Probably something very simple that i am missing, but can anyone help?

Thanks in advance.
 
Well-spotted! Yes, sorry, a left-over technicality from an old era!

The 5% is the assumed gross dividend yield. We've assumed that dividends are taxed at 20% (they used to be, a long time ago, with something called Advance Corporation Tax).

So you can strip out the 0.8 if you like, although you'll see that the GRY assumption is pretty finger-in-the-air anyway.

Thanks for pointing this out.
 
Ah, great, thanks.

I did consider tax, but there was no mention of this in the question (or answer) and couldn't calculate anything close to 20% when looking at gross and net profit.

Thanks for your help.
 
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