ExpertEasy2 marksMultiple Choice
ACCA · Question 12 · Business Valuations
Section A
BioPharma Innovations has just paid a dividend of $0.50 per share. Dividends are expected to grow at a constant rate of 4% per annum in perpetuity. The shareholders' required rate of return (cost of equity) is 10%.
Using the Dividend Valuation Model (DVM), what is the theoretical ex-dividend market price of one share?
Section A
BioPharma Innovations has just paid a dividend of $0.50 per share. Dividends are expected to grow at a constant rate of 4% per annum in perpetuity. The shareholders' required rate of return (cost of equity) is 10%.
Using the Dividend Valuation Model (DVM), what is the theoretical ex-dividend market price of one share?
Answer options:
A.
$5.00
B.
$8.33
C.
$8.67
D.
$12.50
How to approach this question
Apply the Dividend Growth Model formula: P0 = [D0 × (1 + g)] / (Ke - g). Ensure you use D1 (next year's dividend) in the numerator.
Full Answer
C.$8.67✓ Correct
The Dividend Valuation Model formula is P0 = D1 / (Ke - g), where D1 = D0 × (1 + g).
D0 = $0.50
g = 4% (0.04)
Ke = 10% (0.10)
D1 = $0.50 × 1.04 = $0.52
P0 = $0.52 / (0.10 - 0.04) = $0.52 / 0.06 = $8.666... (rounded to $8.67).
Common mistakes
Using D0 ($0.50) in the numerator instead of D1 ($0.52), resulting in $8.33.
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