Could someone help me with this finance question please? Thank you so much. Choi
ID: 2613305 • Letter: C
Question
Could someone help me with this finance question please? Thank you so much.
Choice Properties REIT equity is a candidate for a “bond surrogate” because it pays a stable dividend supported by collecting rent on grocery stores.
a.What is the current dividend (per share) of Choice Properties REIT? How often do they pay?
b.Assuming the dividend never changes, set up a cash flow table for the perpetual dividend and discount the cash flows (back to June 2 again). How do you deal with infinity here? Find a discount rate to get the present value close to the current trading price. Compare to the “dividend yield”: annual dividend divided by price.
c.Reprogram your model to include a growth rate. Assume 3% growth (rent increases and development). What’s the discount rate to get close to the current trading price? Compare to the constant case.
d.Compare these exercises to the annuity, perpetuity and growing perpetuity in the textbook. Do the textbook formulas work?
e.Interest rate risk. Suppose the Fed raises rates more than expected and all discount rates jump by 1%. What’s the percentage price loss on
i.The Ontario long bond
ii.The constant-dividend Choice REIT (g=0%)
iii.The growing Choice REIT (g=3%)
Explanation / Answer
Answer (a)
Current Dividend of Choice Properties REIT = CAD 0.65
Periodicity of Payment = Annual
Answer (b)
The present value of the stock can be calculated by using the formula
P = D1/(1+r)+D2/(1+r)^2 + ... + Dn /(1+r)^n + Pn/(1+r)^n
Where D1 is the dividend payable in year 1 and so on and r is the required rate of return (discount rate) and Pn is the price realised at period n.
Assuming that there is no growth in dividend or the company pays same dividend every year without any change. This is akin to a bond which pays same amount every period without maturity. This reduces the last term Pn/(1+r)^n to zero. That is
P = 0.65/(1+r)+ 0.65 / (1+r)^2 + ... + 0.65 / (1+r)^n where n is infinity
This reduces to
P = 0.65 / r
As the security pays a constant dividend and without any maturity value.
Substituting the Current trading rate of $ 11.35
$ 11.35 = $ 0.65 / r ==> r = 0.65/11.35 = 0.0572687 or 5.73%
Dividend Yield = Annual Dividend / Current Market Price = 0.65 / 11.35 = 5.73%
Answer (c)
Assuming there is a constant growth rate of g = 3%
The above formula changes to
P = D0(1+g)/(1+r)+D0(1+g)^2/(1+r)^2 + ... + D0(1+g)^n /(1+r)^n
P = D0 { (1+g/1+r) + (1+g/1+r)^2 + ... + (1+g/1+r)^n}
This reduces to
P = D1 / r-g where D1 = D0 * (1+g)
Taking the growth rate of 3% and current market price of 11.35
11.35 = 0.65 * (1+.03)/r - 0.03 ==> 11.35 = 0.65*1.03/r-0.03
r- 0.03 = 0.65 * 1.03 / 11.35 = 0.6695/11.35 = 0.058987 ==> r = 0.058987 + 0.03
r = 0.088987 or 8.90%
The dividend yield (required rate of return) using Gordan Model can be calculated as
r = (D1/P) + g = (0.65 * (1.03) / 11.35) + 0.03 = 0.6695/11.35 + 0.03 = 0.058987 + 0.03
r = 8.90%
Answer (d)
The formulas reduce to those provided in finance text books.
Answer (e)
If the discount rates jump by 1%
i.
There will be a similar decrease in price of the bond due to a 1% increase in discounting rate. Further details are needed to calculate the current price of bonds based on period and annual yield.
ii. The constant dividend Choice REIT
ie.,the required rate of return will 5.73 + 1 or 6.73%
Price = 0.65 / 0.0673 = 9.658 or 9.66
Comparing this with the earlier price of 11.35, there is a loss of ((11.35 - 9.66)/11.35) * 100 which is equal to 14.89% loss in price
iii.
r will now be 8.90 + 1 = 9.90%
Price = D0 (1+g) / r - g ==> P = 0.65 * 1.03 / 0.0990 - 0.03 = 0.6695 / 0.069
P = 9.702 or 9.70
Comparing this with the earlier price of 11.35,there is a loss of ((11.35 - 9.70)/11.35 * 100) which is equal to 14.537%.