- 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**

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 D

_{1}, D

_{2}and D

_{3}.

PV of D

_{1}= (1.25*1.23)/1.13 = 1.361; PV of D

_{2}= (1.25*1.23*1.23)/1.13

^{2}= 1.481; PV of D

_{3}= (1.25*1.23*1.23*1.23)/1.13

^{3}= 1.612

Step 2: Find the PV of all dividends beyond year 3: P

_{3}= D

_{4}/(k - q) = (1.25*1.23*1.23*1.23*1.07)/(0.13 - 0.07) = 41.48.

Therefore, PV of P

_{3}= 41.48/1.13

^{3}= 28.75.

Step 3: Sum the PVs of all the components to equal the stock price: P_{ABC} = 1.361 + 1.481 + 1.612 + 28.75 = $33.20.

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**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? |