A firm has a constant growth rate of 7% and just paid a divident of $6.25. If the required rate of return is 12%, what will the stock sell for two years from now based on the DDM?

Formula = D^3/ (k-g) OR Do (1+g)^3 / (k-g)

Simple question but why do you use 3 as an exponent? I would think if you were goinig two years out, D1 would be next years dividend and D2 would the second years dividend.

It’s probably more helpful to view the formula as P(t) = D(t+1)/(r-g).

In other words, the price at any point is based on the NEXT expected dividend. So, if (for example) the question said "the next expected dividend is $3), you would simply use $3 in the numerator (and not 3 x (1+g)).

The only reason you use D(0)(1+g) is to get the next dividend).

So, since you need the price TWO years from now, you need the dividend THREE years from now.

If they’d given you the next expected dividend, that would have been D(1). So in that case, you’d only need to compound it forward two years.