Market uses a dividend valuation model

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Reference no: EM1390063

St Jamesa Ltd. Has just paid a dividend of £0.22 per share. The market expects this dividend to grow constantly in each future year at the rate of 7% p.a. The cost of capital for St Jamesa Ltd. is currently 9%. As soon as the dividend was paid, however, the Board of St Jamesa Ltd. decided to finance a new project by retaining the next three annual dividend payments. The project is seen by the market to be of riskier than existing projects and the cost of capital is estimated to be 10%. It is expected that the dividend declared at the end of the fourth year from now will be £0.30 per share and will grow at the rate of 8% p.a. from then on.

You hold 1,000 shares in St Jamesa Ltd. and your personal circumstances require that you receive at least £200 each year from this investment.

(i) Assuming that there is a perfect market in St Jamesa Ltd's shares, and that the market uses a dividend valuation model, show how the market value of the shares has been affected by the Board's decision.

Reference no: EM1390063

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