# BAII Calculation DDM (Supernormal Growth)

Hey Guys, Please could someone be so kind as to provide the calculator workings for the following problem, this seems like a rather timely problem, do you recon that they would include this in the exam? An analyst gathered the following information about a company: The stock is currently trading at \$31.00 per share. Estimated growth rate for the next three years is 25%. Beginning in the year 4, the growth rate is expected to decline and stabilize at 8%. The required return for this type of company is estimated at 15%. The dividend in year 1 is estimated at \$2.00. The stock is undervalued by approximately: A) \$6.40. B) \$0.00. C) \$15.70. D) \$2.30.

1. estimate terminal value using Gordon formula 2) use CF feature to calculate PV of CF (dividends and terminal value)

The value of stock today is :- PY of Year 1 + PY of Year 2 + PV of Year 3 + PV of Price in Year 3 => 2 / {(1.15)^1} + 2(1.25) / {(1.15)^2} + 2(1.25)(1.25) / {(1.15)^3} + { 2(1.25)^2 / (.15-.08)} / {(1.15)^3} => 1.739130 + 1.890359 + 2.054738 + 31.701675 => \$37.385902 So the Stock is undervalued by = ( \$\$37.385902 - 31) = 6.385902 The Answer should be “A” Is it right ???

Alright so there would be no short cut , to work out this problem on your calculator. I’m sorry Bee i haven;t yet worked it out.

I get A Div1 2.00 Div2 2.5 Div3 3.125 Div4 3.375 (growth at 8%) terminal value 3.375(1.08) / .15-.08 discounted back at 15% = 37.40 - stock price of 31 = 6.4 undervalued.

it really doesn’t take very long to do. just figure out your div’s by using relevant growth rates. term value is final div(1+term growth rate) /k-g. add that term value to your prior period div and plug in the CF function. takes about 2 min i’d say after practicing a few times.

Excellent, thanks Jut111

use the 2nd CF function CF0=0 CF1=2.00 F1=1 CF2=2.5 F2=1 CF3=3.124 F3=1 CF4=3.375+37.40 F4=1 NPV I=15 CPT NPV

CPK123, I see that the princple is correct, but i dont seem to get the same values… I get NPV 28.99 ?

CF0=0 CF1=2.00 F1=1 CF2=2.5 F2=1 CF3=3.124 F3=1 CF4=3.375+ D4 / (ke – g) = \$3.38 / (0.15 – 0.08) = \$48.29 I=15% Gives me NPV \$35.23 ? ?

your Div4 is off. Div 4 should be Div 3 * 1+terminal growth rate. so 3.375*1.08 = 3.645. then to calculate terminal value it is 3.645/k-g so 3.645/.07 = 52.07 Then CF4 is 52.07 + 3.375