ABC Ltd. has an investment opportunity available which will involve a capital outlay in each of
the next 2 years and which will produce benefits during the following 3 years. A summary of the
financial implications of this investment is given below:
Year Cash Flow (Rs ‘000)
1 (1,000)
2 (1,000)
3 100
4 1,300
5 3,100
ABC Ltd. currently has 1,00,000 shares in issue. The dividend just paid was Rs 15 per share.
In the absence of the above investment, dividends are expected at this level for the next 3
years but will then demonstrate perpetual growth of 10 per cent p.a. ABC Ltd. is currently all
equity financed and the required rate of return of the equity investor is estimated to be 18 per
cent. The company has a long established policy of not using any debt finance and, because
of the current depressed state of the stock market, could not in the near future issue new
equity. The only possible way of financing the investment is, therefore, to reduce the
dividend payments made in the next 2 years. Cash received from the new investment will all
be distributed. Growth in dividends @10 per cent will also be maintained because of other
operations.
Required:
a) Calculate the current share price of ABC Ltd.
b) Calculate the share price after the investment has been accepted, assuming the market
knows of the dividend changes that will result from the investment using a Dividend
Valuation Model.