- CFA Exams
- CFA Level I Exam
- Study Session 13. Equity Investments (2)
- Reading 41. Equity Valuation: Concepts and Basic Tools
- Subject 2. Present Value Models: The Dividend Discount Model

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**CFA Practice Question**

Which of the following amounts is closest to what should be paid for Aerodynamic Common stock? Aerodynamic has just paid a dividend of $4.50. These dividends are expected to grow at a rate of 5% forever. The risk of this company suggests that future cash flows should be discounted at a rate of 9%.

B. $118

C. $123

A. $113

B. $118

C. $123

Correct Answer: B

Value of stock = D

_{0}(1+g)/(r-g) = 4.5(1+0.05)/(0.09-0.05) = $118.125###
**User Contributed Comments**
16

User |
Comment |
---|---|

haarlemmer |
$123 stands for the expected dividend! |

ipallete |
The formula needs the NEXT dividend (not yet paid). If we know last dividend and growth rate we can get D1=D0(1+g). |

jade |
But how do you know that you have to use the infinite growth model |

steved333 |
Don't forget to apply the (1+g) to the $123. |

bmeisner |
Hmmm Jade, how do you know to use infinite growth model? Maybe because it says the word forever right in the sentence, ever think of that? |

kutta2102 |
What's with the sarcasm bmeisner? Haven't you ever made a misread a question? |

rfvo |
Anyone know the BA workings? |

rfvo |
LOL, cant believe i posted that...6 months down the line and i dont need my BA any more, takes way to much time. |

CFALucille |
why do you multiple number by 1.05? I thought formula was V = D/k-g |

IvanTG |
Lucille, the question is relating to current dividend value not future, therefore we need to adjust it for the estimated growth of 5%...I got it wrong too ;-) |

thekobe |
Lucille you have to apply V=D*(1+g)/k-g |

johntan1979 |
Yup, got me too. Next period's dividend. |

jonan203 |
you are paying for FUTURE dividends, not dividends that have already been paid. if a stock pays a $5 dividend yesterday and the assumed rate of dividend growth is 5%, you have to discount the future dividend $5(1.05) by the spread between the discount and growth rate. discount the future $5.25, not the past $5.00 |

davidmort |
I got 117 |

tochiejehu |
use d Constant Growth formular to get the answer |

kseeba17 |
Just learn how to use a normal calculator people, that way you actually understand it. |