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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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FOREIGN INVESTMENT ANALYSIS After all foreign and U.S. taxes, a U.S. corporation expects to receive 2 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $1.53 per pound, and the pound is expected to depreciate 5% against the dollar each year for an indefinite period. The dividend (in pounds) is exported to grow at 10% a year indefinitely. The parent U.S. corporation owns 10 million shares of the subsidiary. What is the present value in dollars of its equity ownership of the subsidiary? Assume a cost of equity capital of 11% for the subsidiary.

Summary Introduction

To determine: The present value of the equity in terms of dollars.

Introduction:

Exchange Rate:

The rate which indicates the conversion rate for the currency of a country and which can be obtained in exchange of the currency of another country is an exchange rate.

Currency Depreciation:

It indicates the positive (increase) change in the currency’s value in reference to any other currency. The change may be due to some factors such as change in government policies, and fluctuation in interest rates.

Explanation

Given information:

The expected amount of dividends per share is 2 pounds.

The exchange rate of a pound in dollar is $1.53.

The value of pound in reference of dollar is depreciated at 5% or 0.05.

The amount of dividend expected to appreciate (in pounds) by 10% or 0.10.

The number of shares of subsidiary is 10 million.

The cost of equity is 11% or 0.11.

Firstly, calculate the price per share for computation of total equity.

Price per share:

Formula to calculate the price per share,

P0=D1reg

Where,

  • P0 is the price per share.
  • D1 is the dividend at the end.
  • re is the cost of equity capital.
  • g is the actual growth in dividend.

Substitute (2×$1.53) for dividend in dollars, 0.11 for cost of equity, and 0.047619 for growth in dividend (working note) in the above formula.

P0=2×1.530.110.047619048=3.060.0623809524=$49

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