## Related questions with answers

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 expected 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.

Solution

VerifiedThis problem gives us four important variables-

Cost of equity capital=11%

Dividend growth of 10$\ Exchange rate is$\$1.53$ per pound

Depreciation of pound is 5% against $\$1$

With this information we can almost complete the following equation and determine the price of the shares-

Price=$\dfrac{\text{Dividend at end of period}}{\text{cost of equity capital}-\text{Growth in dividend}}$

Before we can complete that equation, we need to find the growth in the dividend, which can be done using the following equation-

Growth= $\dfrac{1+\text{dividend growth}}{1+\text{depreciation}}-1$

Growth= $\dfrac{1+0.10}{1+0.05}-1$

Growth= 0.047619048.

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