- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Valuation
- Learning Module 23. Discounted Dividend Valuation
- Subject 2. The Dividend Discount Model
CFA Practice Question
A company's required rate of return is 13.1%. An analyst expects the company to pay $10 in dividends next year. The company's stock is currently trading at $60 and is expected to fall to $58 by the year-end. The alpha of the company is
A. 0.2%
B. 0.0%
C. -0.2%
Explanation: Expected holding period return is the sum of dividend yield and price appreciation: r = D1/P0 + (P1 - P0)/P0 = 10/60 + (58 -60)/60 = 13.33%.
Alpha equals the difference between this expected holding-period return and the required rate of return: alpha = 13.33 - 13.1% = 0.2%.
Alpha equals the difference between this expected holding-period return and the required rate of return: alpha = 13.33 - 13.1% = 0.2%.
The positive value of alpha indicates that the stock is an attractive stock for investors with a single-period horizon.
User Contributed Comments 2
| User | Comment |
|---|---|
| siggarusfigs | why don't we discount the cash flows to the present? |
| DariSH | You can easily apply DCF method here too: 1. Do the DDM calc: (58+10)/(1+0.131) = 60.123 2. calc the alpha, %: (60.123-60)/60 = 0.00205 or 0.2%. |