Discussion question 3

If the interest rates increase, the present value of future dividends of a company would
increase or decrease? What that may do to the price of a share of that company?
Present value of future dividends of a company
Present value is the current market value that estimated to reached certain amount (Guell,
2012). If interest rate remains constant, Present value of future dividends is calculated as,
Present value = Payment / (1+ r)t
Payment = payment received to be in future.
r = required rate return of interest paid.
t = number of years before payment is received.
If interest rate changes, present value of future dividends is calculated as,
Vo = C1/(1+r)1 + C2/(1+r)2+ C3/(1+r)3 + + Ct/(1+r)t + Cn/(1+r)n
Where,
Vo = the current or present value of an investment,
Ct = expected returns at time t,
kt = required rate of return for each period,
n = the number of periods over which returns are expected to be generated (Olweny, 2011)
(Olweny, 2011).
Assumed that interest remains constant, present value of future dividends remains decrease with
increase in interest rate.
For examples,
Payment = $500
When interest rate = 7%

Then, Present Value = 500 / (1+0.07) = $476.29(estimated).

When interest rate = 8%
Then, Present Value = 500/ (1+0.08) = $462.96 (estimated).
From calculation, we can predict that present value of future dividends is inverse proportional to
increase rate. Present Value is need in economics to judge that investing in share gives benefit
than saving in bank account or investing in owns business.
The same principles are used to the price of share of the company. Increase in interest rate
decrease the share values of the prices. The company increase interest rate means gives more
interest and have loss money for invest that ultimate decrease the share values of prices of
shareholders (Fairfield, 1994).
References
Guell, R. C. (2011). Issues In Economics Today. The MCGraw-Hill series economics.
Fairfield, P. M. (1994, July-August). P/E, P/B and the Present Value of Future Dividends.
Financial Analysts Journal, 50(4), 23-31. Retrieved from
http://www.jstor.org/stable/4479758?origin=JSTOR-pdf&seq=1#page_scan_tab_contents
Olweny, T. (2011). The Reliability of Dividend Discount Model in Valuation of Common Stock
at Nairobi Stock Exchange. International Journal of Business and Social Science, 2(6),
127-141.