Lecture 8

Question 1

Zero Growth Dividends

Answer 1

The value of the shares is simply an ordinary perpetuity

Question 2

Constant growth dividends

Answer 2

Value of the shares is given by the Gordon growth model

Question 3

Non Consant (Differential) growth

Answer 3

Calculate the share value by:
- Calculate the PV of all shares growing at x% per year
- Calculate the PV of all shares growing at y% per year
- P0 = Step 1 + Step 2

Question 4

Retention Ratio

Answer 4

• We assume the growth rate of the dividends = growth rate of the business
• If dividends are growing at a constant rate the firm must have a constant retention ratio
• If the firm pays out all earnings as dividends the retention ratio will be zero and the firm will stop growing

Question 5

Limitations of DDM

Answer 5

• Estimation of g is not precise
• Estimation of R is highly dependant on g
• Lack of consideration in growth opportunities
• No-dividend firms

Question 6

Clean Price

Answer 6

= the price of the bond net of accrued interest it is the quoted price

Question 7

Dirty Price

Answer 7

= The price of the bond including incurred interest, it is the price the buyer pays

Question 8

Bond Valuation

Answer 8

• Calculating the PV and coupon of a bond
  using table a4 to find the annuity factor for a level coupon bond

Question 9

Relationship between bond price and interest rates

Answer 9

Negatively correlated