An investment business is considering taking a minority stake in two businesses, Monaghan plc and Cavan plc. Both are in the same line of business and both are listed on the London Stock Exchange. Monaghan plc has had a stable dividend policy over the years.

In the financial reports for the current year, the chairman stated that a dividend of 30p a share would be paid in one year’s time and financial analysts employed by the investment business expect dividends to grow at an annual compound rate of 10 per cent for the indefinite future.

Cavan plc has had an erratic dividend pattern over the years and future dividends have been difficult to predict. However, to defend itself successfully against an unwelcome takeover, the business recently announced that dividends for the next three years were expected to be as follows:

Financial analysts working for the investment business believe that, after Year 3, Cavan plc will enjoy a smooth pattern of growth, and dividends will be expected to grow at a compound rate of 8 per cent for the indefinite future.

The investment business believes that a return of 14 per cent is required to compensate for the risks associated with the type of business in which the two businesses are engaged.

Ignore taxation.

Required:

(a) State the arguments for and against valuing a share on the basis of its future dividends.

(b) Calculate the value of a share in:

(i) Monaghan plc 

(ii) Cavan plc 

based on the expected future dividends of each business.

Transcribed Image Text:

Year 123 со по 3 Dividend per share (pence) 20 32 36