# DDM question from Qbank...wrong solution i guess!

hi… here is the question: Bybee is expected to have a temporary supernormal growth period and then level off to a “normal,” sustainable growth rate forever. The supernormal growth is expected to be 25 percent for 2 years, 20 percent for one year and then level off to a normal growth rate of 8 percent forever. The market requires a 14 percent return on the company and the company last paid a \$2.00 dividend. What would the market be willing to pay for the stock today? A) \$52.68. B) \$47.09. C) \$76.88. D) \$67.50. ================================================== don go down if u dnt wanna se the answer :P) ================================================== thats qBank solution: First, find the future dividends at the supernormal growth rate(s). Next, use the infinite period dividend discount model to find the expected price after the supernormal growth period ends. Third, find the present value of the cash flow stream. D1 = 2.00 (1.25) = 2.50 (1.25) = D2 = 3.125 (1.20) = D3 = 3.75 P2 = 3.75/(0.14 - 0.08) = 62.50 N = 1; I/Y = 14; FV = 2.50; compute PV = 2.19. N = 2; I/Y = 14; FV = 3.125; compute PV = 2.40. N = 2; I/Y = 14; FV = 62.50; compute PV = 48.09. Now sum the PV’s: 2.19 + 2.40 + 48.09 = \$52.68. i think its wrong! didnt he forget about the third dividand calculation…the correct answer should be B

Ans is A D1 = 2.5 D2 = 3.125 D3 = 3.75 P3 = 3.75 * 1.08 / (.14 - .08) = 62.5 Now with the Cash flows calc PV at 14% ==> 52.69

No the answer is A. = (2.5/1.14) + (3.125/1.14^2) + ((3.75 + 67.5)/1.14^3) = 52.68 3.75(1.08) = 4.05 4.05/.14-.06 = 67.5 You messed up by not compounding the third dividend by the normal growth rate of 8% to use in the constant DDM

yeah thanx i solved it again with a clearer mind i found my mistake. i treated p3 as p4 and disounted it as it was on fourth year.

Answer is correct: Here is diff way of calculating: D4 = 4.05 P3 = 4.05/.06 = 67.5 D3 = 3.75 So total cash flow in 3 year = 71.25. PV of 3 year cash flow = 48.09. Sum = 2.19 + 2.4 + 48.09 = 52.68.

are you guys using the TVM functions to calc this problem? I actually find it easier just to type all the equations in my calculator

Cash flow function on my TI BA II Plus for the last step is what I do

yeah use CF function. just easier then having to square, then cube etc.

yea true, but you still have to find the 4th dividend to use in the constant DDM