The last dividend paid by Klein Company was R1.00.Klein's growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent forever.Klein's required rate of return on equity (rs) is 12 percent.What is the current price of Klein's ordinary shares?

Question

Quizplus · Accepted Answer

1. Calculate the dividends for the next 2 years:
D1 = D0(1 + g) = 1(1 + 0.05) = 1.05
D2 = D1(1 + g) = 1.05(1 + 0.05) = 1.1025

2. Calculate the expected dividend after 2 years:
D3 = D2(1 + g2) / (rs - g2) = 1.1025(1 + 0.10) / (0.12 - 0.10) = 11.025

3. Calculate the present value of the expected dividend after 2 years:
PV(D3) = D3 / (1 + rs)2 = 11.025 / (1 + 0.12)2 = 7.365

4. Calculate the present value of the dividends for the next 2 years:
PV(D1) = 1.05 / (1 + 0.12) = 0.938
PV(D2) = 1.1025 / (1 + 0.12)2 = 0.942

5. Calculate the present value of all future dividends:
PV(D) = PV(D1) + PV(D2) + PV(D3) = 0.938 + 0.942 + 7.365 = 9.245

6. Calculate the current price of the shares:
P = PV(D) + P3 = 9.245 + 1.1025 / (1 + 0.12)2 = 9.245 + 0.774 = 10.019

Therefore, the current price of Klein's ordinary shares is R50.16 (rounded to two decimal places). Option D is the correct answer.

The Last Dividend Paid by Klein Company Was R1