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question from april 2000

M

mayughodake9

Member
An investor is considering the purchase of 100 ordinary shares in a company. Dividends from the share will be paid annually. The next dividend is due in one year and is expected to be 8p per share. The second dividend is expected
to be 8% greater than the first dividend and the third dividend is expected to be 7% greater than the second dividend. Thereafter dividends are expected to grow at 5% per annum compound in perpetuity. Calculate the present value of this dividend stream at a rate of interest of 7% per annum effective

solution=

100 shares provide a first dividend of £8.

Present value = 8(v + 1.08v2 + 1.08*1.07*v3+ 1.08 *1.07 *1.05v4+
1.08 *1.07* 1.05^2* v5+.............)

there is increase of 8 % in 2 nd year then why 1.08 is taken in 3rd year.

sililarlly from 4th year increase in 5% why 1.08 and 1.07 term taken into that.? wht is reason?
 
The dividend in the second year is 8*1.08.

The question says that the dividend in the third year is 7% greater than the dividend in the second year. That's (second dividend)*(1.07) = 8*1.08*1.07.

The fourth dividend follows similarly, ie it is 5% greater than the third dividend.
 
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