2-stage DDM

I am trying to understand how to calculate the first stage of constant growth for x amount of years. I am specifically referencing Schweser Practice Exam 3 Morning Session question #14. I have gotten the correct answer by summing each divident discounted back appropriately but isn’t there a way to the following: 3 years dividend growth of 11% which is given in the question: 2009, 2010, 2011 Dividend: 2.13, 2.36, 2.63 rescpectively (this reflects the 11% growth) Isn’t there a way to be able to do 2.13(1+.11)^3/(1+r)^3 to get the present value of those 3 dividends instead of summing them individually? In addition, when calculating the terminal value I have the formula Do(1+short-term rate)^x (1+constant growth rate)/r-g. When I do this I do not get the correct answer. Where am I going wrong?

Set up DDMs this way. Find your CFs by discounting the dividends. On the last dividend add your Terminal Value to it. So the last cash flow is ending dividend plus the TV. Set CF0=0, put in the above calculated CFs for 0,1,2…n Put in discount rate and periods. Solve for NPV. Done.

piwanoi is right. you know the first 3 cash flows, so enter: CF0(outlay)=0 CF1= 2.13 CF2= 2.36 CF3= 2.63 hit [NPV] it will ask for Interest rate, which you know you are discounting by 11% (enter as 11). Press down arrow, then CPT. NPV = 5.76 When calculating the terminal value you need a growth rate forever, lets say 5%. to get Value @ t=3 (after supernatural growth stops) you need: V3 = D4 / r - g V3 = D3(1+.05)/ .11 - 0.5 V3 = 2.63(1.05)/ .06 V3 = 2.76/0.06 V3 = $46 Now remember you have to discount this back to t=0. NPV of V3 = $46 / 1.11^3 = $33.63 then you add $33.63 with $5.76 and get $39.39. What I like to do is add the $46 CF to CF3, and then recompute NPV CF0(outlay)=0 CF1= 2.13 CF2= 2.36 CF3= 2.63+46 = 48.63 NPV -> [CPT] = $39.39

So basically you are saying don’t worry about the convention of the formula and use the calculator once you have all relevant cash flows? My second question is there a way to get the dividends more effectively without multiplying each divident by the growth? For example if I wasn’t given the dividends from the example above what is the quickest way to arrive at ONLY the period dividend with the constant growth rate (2.63 * 1.04).

If your 2 stage DDM is using a declining growth rate for a number of years, then you need to use the H-model. I think this is a much more probable.

@mbolzicco: What is the most efficient way to arrive at D4 without the 3 dividends at 11% given to you is my follow up question.

H-model must use formula?

I think you will prob be given the dividends. If not you will be given the info necesary to compute dividends, like EPS & retention ratio (b) or EPS and dividend payout ratio. They will also probably make you compute G, by giving you either ROE, or ROA & Leverage (ROA*Leverage=ROE).

H model is a MUST know.

The best way to get D4 is to start at D0, and multiply the growth rates. You have to be given the dividends OR at the very least the necessary inputs to compute the dividends.

He is confusing you, mike_alts. H-model is only applicable when the dividend growth from a period of high growth to lower, stable growth is a constant linear function. It is NOT applicable in this case.

Mike said: 2009, 2010, 2011 Dividend: 2.13, 2.36, 2.63 rescpectively (this reflects the 11% growth) Isn’t there a way to be able to do 2.13(1+.11)^3/(1+r)^3 Mike referencing your original question. You were on the right track but had a minor calculation error in your thinking. You will find if you adjust to match the correct years you should get the right answer. It may be faster to use CF buttons. … its only 2 years from 2009 to 2011. so 2.13(1.11)^2 = 2.6244 (your year 3 dividend because you are starting with 2009) Then if you divide by the interest rate to the third power for years. you get the PV value in 2008. You can use your formula and you should get the same answer. Just remember you PV your terminal value for 3 years too.

The answer is, “yes”, you do not need to discount them. They are growing at the same rate as the discount. So their NPValue is 3 * (2.13)/1.11 = 5.76 As for after that, you take the PV of the perpetuity of the future dividends (i don’t have schweser or the problem, so bear with me), which is [2.63*(1.05)/(.11 - .05)] / (1.11^3) = 33.65. The total of these components is now 5.76 + 33.65 = 39.41