Answered step by step
Verified Expert Solution
Question
1 Approved Answer
1. An investor that pays income tax of 25% on dividend income is considering investment into 2 different companies, Company A and Company B. Company
1. An investor that pays income tax of 25% on dividend income is considering investment into 2 different companies, Company A and Company B. Company A pays dividends on 1 April and 1 October each year. The last dividend paid was on 1 October 2020 at 3p per share. Dividends are expected to grow on 1 April each year by 15% per annum for the first 3 years, and then 3% per annum in perpetuity thereafter. Dividends on 1 October each year are expected to be the same as the April dividend earlier in that same year. (a) Draw a timeline and set out a table showing the timing and value of the expected dividend stream per share for Company A. [2] (b) Calculate the ex-dividend price per share for Company A that the investor would be prepared to pay on 1 March 2021, in order to achieve an annual net effective rate of return of 8% per annum. [5] Company B pays dividends quarterly, on 1 February, 1 May, 1 August and 1 November each year. The last dividend paid was 2p per share on 1 February 2021. Dividends are expected to remain level until 1 May 2022 when the dividend paid on that date is expected to increase to 3p per share, and then to continue to increase by 1% every quarter in perpetuity thereafter. (c) Draw a timeline and set out a table showing the timing and value of the expected dividend stream per share for Company B. [2] (d) Calculate the effective interest rate per quarter when i = 8% per annum. [1] [5] (e) Preferably using your answer in (d) above, calculate the price per share for Company B that the investor would be prepared to pay on 1 March 2021, in order to achieve an annual net effective rate of return of 8% per annum. (f) Comment on the valuation of the share dividend stream for each company, and why from outset you expect one company's market price per share to be higher or lower than the other company's market price per share. The current market share price for Company A is 120p per share, and for Company B is 110p per share. [3] (g) If the investor can only invest in one of these companies, which should they choose, and why? [2] [Total 20 Marks] 1. An investor that pays income tax of 25% on dividend income is considering investment into 2 different companies, Company A and Company B. Company A pays dividends on 1 April and 1 October each year. The last dividend paid was on 1 October 2020 at 3p per share. Dividends are expected to grow on 1 April each year by 15% per annum for the first 3 years, and then 3% per annum in perpetuity thereafter. Dividends on 1 October each year are expected to be the same as the April dividend earlier in that same year. (a) Draw a timeline and set out a table showing the timing and value of the expected dividend stream per share for Company A. [2] (b) Calculate the ex-dividend price per share for Company A that the investor would be prepared to pay on 1 March 2021, in order to achieve an annual net effective rate of return of 8% per annum. [5] Company B pays dividends quarterly, on 1 February, 1 May, 1 August and 1 November each year. The last dividend paid was 2p per share on 1 February 2021. Dividends are expected to remain level until 1 May 2022 when the dividend paid on that date is expected to increase to 3p per share, and then to continue to increase by 1% every quarter in perpetuity thereafter. (c) Draw a timeline and set out a table showing the timing and value of the expected dividend stream per share for Company B. [2] (d) Calculate the effective interest rate per quarter when i = 8% per annum. [1] [5] (e) Preferably using your answer in (d) above, calculate the price per share for Company B that the investor would be prepared to pay on 1 March 2021, in order to achieve an annual net effective rate of return of 8% per annum. (f) Comment on the valuation of the share dividend stream for each company, and why from outset you expect one company's market price per share to be higher or lower than the other company's market price per share. The current market share price for Company A is 120p per share, and for Company B is 110p per share. [3] (g) If the investor can only invest in one of these companies, which should they choose, and why? [2] [Total 20 Marks]
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started