1 Terracotta plc has paid an annual dividend of 15p per share over the past 20 years and the current ex dividend market

Question

1 Terracotta plc has paid an annual dividend of 15p per share over the past 20 years and the current ex dividend market price of its shares is £1.36p. The company is considering accepting a new project, which it will finance by suspending dividends for the next 3 years. After this period, the company will pay an increased dividend of 19p per share for the foreseeable future. If the company takes on the project and uses the proposed method of financing, what will be the expected share price? a) £1.36 b) £1.72 c) £1.60 d) £1.26 e) £1.13 2 Purchasing power parity states that the price of a similar good will be same in two countries. So in the given scenerio McDonald's Big Mac costs 2.36 yuan in China but costs $4.13 in the United States 2.36 yuan = $ 4.13 1$ = 2.36 / 4.13 1$ = 0.5714 yuan As the purchasing power parity exists so, in order to purchase 1 U.S Dollar we would require 0.5714 Chinese Yuan

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1 1] The required return on the company's equity is to be found out from the existing price and dividends. The dividends being constant [0 growth], share price is given by: P0 = D/rs, wehre rs is the required return, P the current share price and D the constant dividend. Substituting values in the above equation we have, 1.36 = 0.15/rs rs = 0.15/1.36 = 11.03% 2] Price at the end of year 3 = 0.19/0.1103 = £ 1.72 Price today = 1.72/1.1103^3 = £ 1.26 Answer: [d] £1.26 2 Purchasing power parity states that the price of a similar good will be same in two countries. So in the given scenerio McDonald's Big Mac costs 2.36 yuan in China but costs $4.13 in the United States 2.36 yuan = $ 4.13 1$ = 2.36 / 4.13 1$ = 0.5714 yuan As the purchasing power parity exists so, in order to purchase 1 U.S Dollar we would require 0.5714 Chinese Yuan

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1 Terracotta plc has paid an annual dividend of 15p per share over the past 20 years and the current ex dividend market price of its shares is £1

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Archived Solution

1]	The required return on the company's equity is to be
	found out from the existing price and dividends. The
	dividends being constant [0 growth], share price is given
	by:
	P0 = D/rs, wehre rs is the required return, P the current
	share price and D the constant dividend.
	Substituting values in the above equation we have,
	1.36 = 0.15/rs
	rs = 0.15/1.36 =	11.03%
2]	Price at the end of year 3 = 0.19/0.1103 =	£ 1.72
	Price today = 1.72/1.1103^3 =	£ 1.26
	Answer: [d] £1.26