This is scaring me because I used to remember how to do these problems 2 months ago… This # 89 from Exam 3 PM: A stock has a steady 5% growth rate in dividends. The required rate of return for stocks of this risk class is 15%. The stock is expected to pay $1 dividend this coming year. The expected value of the stock at the end of the fourth year is: a) $10.00 b) $12.16 c) $14.21 d) $16.31 The correct is answer is supposedly B (this is what I would liked explained to me). I believe it is calculated as 1*(1.05^4)/ (.15-.1)= 12.16. Please correct me if I’m wrong and am misinterpretting the CFA text but according to Problem 10 part C in Reading 60 on page 202, the correct answer to the above problem should be 1*(1.05^5)/ (.15-1.) = 12.76. As I understand it, we would need the future dividend in year 5, not the current dividend in year 4. Is this a mistake in the Schweser exam or am I just very confused? Here’s the CFA example (problem 10c page 202 book 5): If 8% rate of growth is achieved, what will the price be at the end of year 3, assuming 12% required rate of return and a dividend of $1.25 was paid yesterday. Answer is 1.25*(1.08^4)/ (.12-.08) = 42.52. This seems to be inconsistent to me. Schweser is using the dividend in the year they’re asking us to solve for. Whereas CFA text is using the next year’s dividend. E.g. Schweser is using the 4th year dividend for the price of the fourth year vs. CFA using the 4th year dividend for the price in the 3rd year. I’m sure this is a very convoluted post. but I would greatly appreciate if someone understands this and doesn’t mind explaining. Thanks
They’re both right. Read the questions more carefully. In the schweser problem, the dividend is expected to be $1 in a year (wasn’t paid yesterday, as in example two) 0 1 2 3 4 5 | | | | | | - 1 1.05 1.1025 1.1576 1.2155 Also, the denominator in your solution seems to be wrong, as it should be k-g, thus .15-.05 = .1
It is not inconsistent. In the Schweser problem, the dividend given is the next dividend to be paid (dividend expected to be paid next coming year), in the CFAi text, is the last dividend paid (dividend paid yesterday). If you draw a time line, it will come to you.
have you written it out correctly? 1*(1.05^4) / (0.15-0.05) = 1.215508/ 0.1 = 12.155 If you use the respective divis of $1 and $1.25 in the questions then take growth return away from expected market sorry if i am not getting, it but I can’t see too much of a problem?
Thank you very much. I did incorrectly write out the solution, but that wasn’t my problem. I have to read more carefully. Future dividend vs current dividend is my problem. Thanks
mp just remember that “forward looking” dividend will give you current price. So 1) the problem already states that this is forward looking – “coming year” …so end of 4th yr means ^4. So should be str8 forward at this point. In 2) “yesterday’s price” indicates current, so +1 is warranted. And goes on to say end of y3. This should mean 3+1=4. So ^4. Hope this helps.
Tks for the refresher, it is once again the detail waiting for us… I looked at 10c p202 and it does say “$1.25 was paid yesterday” and “expected” in the schweser question…you just know in the exam one of the choices will be the miscalculation, waiting to snare those of us who are perhaps too eager or skim reading!
Yeah I know, i almost feel at a disadvantage with english being my 1st language. I blow through problems way to quickly…