# CFA Level II Dividend Discount Model Question

You believe the Gordon (constant) growth model is appropriate to value the stock of Reliable Electric Corp. The company had an EPS of \$2 in 2008. The earnings in the next year without the additional planned investments are expected to remain at \$2. The retention ratio is 0.60. The company is expected to earn an ROE of 14 percent on its investments and the required rate of return is 11 percent. Assume that all dividends are paid at the end of the year.

Q. Estimate the value of the company’s stock at the beginning of 2009.

The company paid a dividend per share of 1 − b (EPS) = 0.40(\$2) = \$0.80 in 2008. The estimated value at the beginning of 2009 is

V0=D1r−g=0.80(1+0.0840)/0.1100−0.0840=\$33.35

Does anybody know where the 0.084 growth rate come from? How is it derived from information provided in the question. Am I missing something?

g = b * ROE (Retention Ratio * Return on Equity). Both are provided in the question.

right how did i forget that…THanks!