- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Valuation
- Learning Module 23. Discounted Dividend Valuation
- Subject 7. Multistage Dividend Discount Models

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**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 / 1.08

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 / 1.08

^{2}+ 3.993 / 1.08^{3}+ 82.26/1.08^{3}= 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 |