- 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
CFA Practice Question
ABC Corporation just paid a dividend of $1.25 per share. These dividends are expected to grow at 23% over the next three years and thereafter come in line with its long-term normalized growth rate of 7%. If investors currently require a 13% rate of return from this stock, what is the best estimate of ABC's current stock price?
A. $33.20
B. $42.20
C. $45.93
Explanation: Step 1: Find the PV of D1, D2 and D3.
PV of D1 = (1.25*1.23)/1.13 = 1.361; PV of D2 = (1.25*1.23*1.23)/1.132 = 1.481; PV of D3 = (1.25*1.23*1.23*1.23)/1.133 = 1.612
Therefore, PV of P3 = 41.48/1.133 = 28.75.
PV of D1 = (1.25*1.23)/1.13 = 1.361; PV of D2 = (1.25*1.23*1.23)/1.132 = 1.481; PV of D3 = (1.25*1.23*1.23*1.23)/1.133 = 1.612
Step 2: Find the PV of all dividends beyond year 3: P3 = D4/(k - q) = (1.25*1.23*1.23*1.23*1.07)/(0.13 - 0.07) = 41.48.
Therefore, PV of P3 = 41.48/1.133 = 28.75.
Step 3: Sum the PVs of all the components to equal the stock price: PABC = 1.361 + 1.481 + 1.612 + 28.75 = $33.20.
User Contributed Comments 11
| User | Comment |
|---|---|
| poojacfa | the fourth year div grows by 7%, not 23%!! |
| achu | Remember, last item (lump sum for constant growth pieces is ALSO at t=3, NOT t=4 |
| octavianus | You can't use DDM model for early year abnormal growth since Ks<g... Have to discount each dividend (CF) individually instead. |
| wink26 | Don't forget to adjust the last CF for TVM!!! |
| mcspaddj | 1st div shouldn't be included because it has been paid. The next dividend 1.23*1.25 is the T1 dividend. |
| shiva5555 | Solid question, no tricks if you can do this you got DDM down pretty well. Know it for the test. |
| dipu617 | How can I do it in Texas BA II Plus? Anybody? |
| birdperson | i can help you out dipu617 use the CF function and plug in the appropriate values... store each of the prior values to aid in the speed of the calculation CF1 = (1.25 * 1.23) CF2 = (1.25 * 1.23 * 1.23) CF3 = ((1.25 * 1.23 *1.23*1.23) + ((1.25 *1.23*1.23*1.23*1.07)/(0.13 - 0.07)) then use the NPV function I = 13 CPT NPV =33.2027 DONE. |
| farhan92 | the div of p4 can cause some problems! |
| merc10112 | birdperson...you are just awesome! |
| Cunctator | Why the H-Model isn't applicable here? |