Final answer:
To calculate Fin Corp's current share price, one must discount the expected dividend payments for the next three years and the terminal value using the required return rate. Differences between ordinary shares and preference shares include voting rights, dividend payments, and claims on assets.
Step-by-step explanation:
Current Share Price Calculation
Fin Corp is undergoing rapid growth, with its dividends expected to grow at a rate of 15% for the next three years before settling down to a constant rate of 4.5%. To determine the current share price, we need to calculate the present value of all future dividends. With a required return rate of 12%, and a recent dividend payment of $1.85, we use the Gordon Growth Model to project and discount the dividends. The dividends for the next three years will be:
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- Year 1: $1.85 * (1 + 0.15) = $2.1275
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- Year 2: $2.1275 * (1 + 0.15) = $2.4466
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- Year 3: $2.4466 * (1 + 0.15) = $2.8136
At the end of the third year, the dividend will grow at a constant 4.5%, so the fourth-year dividend is: $2.8136 * (1 + 0.045) = $2.9400.
Now, the share price at the end of the third year, also known as the terminal value, is calculated by the Gordon Growth Model:
Terminal Value = D4 / (r - g) = $2.9400 / (0.12 - 0.045) = $46.221
The current share price is the present value of the dividend payments for three years plus the present value of the terminal value:
Current Price = PV(D1) + PV(D2) + PV(D3) + PV(Terminal Value)
This requires discounting each dividend and the terminal value back to the present using the formula:
PV = D / (1 + r)^t
Where PV is the present value, D is the dividend, r is the required return, and t is the time in years.
After discounting, we add these values to get the current price of the share.
Differences Between Ordinary Shares and Preference Shares
Ordinary shares, also known as common shares, typically carry voting rights and may receive dividends, though these are not guaranteed. Preference shares usually do not provide voting rights but offer a fixed dividend rate. Additionally, preference shareholders have priority over ordinary shareholders when it comes to dividend payments and claims on assets during liquidation.