CFA Practice Question

There are 191 practice questions for this study session.

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

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?
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