Question 10.S-TQ4: The ordinary shares of Chock-stock plc are currently quoted ...
The ordinary shares of Chock-stock plc are currently quoted at 200p per share and the company has been paying a dividend of 30p per share for 10 years. The company is planning to retain the next three years’ dividends to invest in a new project. The project cash flows will begin in year 4 and the company will pay an increased dividend of 40p per share from that year onwards. What is the change in the share price?
(a) -24.7p
(b) -14.2p
(c) 5.8p
(d) 0.2p
(e) 17.6p
Calculating the cost of equity:
K_e = D_0/P_0 = 30/200 = 15%
Value in year 3 of dividend of 40p per year paid in perpetuity = 40/0.15 = 266.7p
Discounting back to the current time: P_0 = 266.67/(1.15)³ = 175.3p
The share price has dropped by 200 – 175.3 = 24.7p
Option (a) is therefore the correct answer.