Shoeworld’s most recent dividend was $0.15 (15 cents). The current share price i

Question

Shoeworld’s most recent dividend was $0.15 (15 cents). The current share price is $8.20. They have just announced a large project which they believe will bring in increasing revenues. This will lead to an increase in dividends. The CEO has announced that dividends will grow at a constant rate of 9%.

If you have a required return of 11%, calculate the maximum price you would pay for the share. Is the current market price over of undervalued?

You believe that the CEO is being overly optimistic and that the actual growth rate of the dividends is more likely to be 6%. Recalculate the price of the share and compare.

Explanation / Answer

Impact on dividend due to new project

0.15 * (1.09) = 0.1635 or 16.35 cents

Price with new dividend = D1 / k - g

D1 =new dividend ; k = required rate of return ; g = growth

P0 = 0.1635 / (0.11 - 0.09) = $ 8.175

Maximum price I would pay for the share is $ 8.175

Yes the current market price is overvalued

If g = 6%

0.15 * (1.06) = 0.159 or 15.9 cents

P0 = 0.159 / (0.11 - 0.06) = $ 3.18

New price per share = $ 3.18

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