- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Valuation
- Learning Module 21. Discounted Dividend Valuation
- Subject 7. Multistage Dividend Discount Models
CFA Practice Question
An analyst has gathered the following data to value a firm:
- The firm's beta: 0.9.
- Required rate of return: 8%.
- The firm paid a dividend of $3 in the current year. It is expected to grow by 10% annually for the next three years and 3% per year thereafter.
- Payout ratio: 30%.
What should the stock price be?
Correct Answer: Step 1: Calculate the dividends for the next three years.
Year 1: 3 x 1.1 = $3.3.
Year 2: 3.3 x 1.1 = $3.63.
Year 3: 3.63 x 1.1 = $3.993.
Terminal value = Dividend per share / (required rate of return - terminal growth rate) = (3.993 x 1.03) / (0.08 - 0.03) = $82.26.
Stock price = 3.3/1.08 + 3.63 / 1.082 + 3.993 / 1.083 + 82.26/1.083 = 3.056 + 3.112 + 3.17 + 65.3 = $74.638.
Year 1: 3 x 1.1 = $3.3.
Year 2: 3.3 x 1.1 = $3.63.
Year 3: 3.63 x 1.1 = $3.993.
Step 2: Calculate the terminal value.
Terminal value = Dividend per share / (required rate of return - terminal growth rate) = (3.993 x 1.03) / (0.08 - 0.03) = $82.26.
Step 3: Discount the terminal value and dividends:
Stock price = 3.3/1.08 + 3.63 / 1.082 + 3.993 / 1.083 + 82.26/1.083 = 3.056 + 3.112 + 3.17 + 65.3 = $74.638.
User Contributed Comments 4
| User | Comment |
|---|---|
| quanttrader | why can't we use the H model here? |
| quanttrader | ahh I get it, use the H model when supernormal growth is not constant rather converges to the sustainable growth rate; use the multi-period dividend model when supernormal growth is constant. |
| b25331 | To save time at the exam, find cash flows and plug them into the BAII calculator - it will take under a minute y1 = 3.3 (C01) y2 = 3.63 (C02) y3 = 3.993 + (3.993 x 1.03) / (0.08 - 0.05) = 86.253 (C03) I = 8 NPV result = 74.638 |
| jbrecevic | ^ Denom should be Long term growth rate, not .05, (.08-.03) = .05 |