EOC question from Schweser Titan Industries is not expected to pay a dividend until ten years from now, at which time it will pay a dividend of 1.25 and then increase the dividend at a rate of 4% thereafter. If the required rate of return is 12%, the current value is closest to A. 5.64 B. 12.78 C. 15.63 Since the terminal growth rate starts from year 11, I discount the cash flow for 10 years. Terminal value = 1.25(1+.04)/(.12-.04) = 16.25 Dividend in Year 10 = 1.25 So I discount the 16.25+1.25 = 17.5/(1.12)^10 = 5.6345 Schweser has a BS explanation which I can’t see the value in: We calculate the value of the expected cash flows at 9 years because the formula uses the value of the dividend of “t+1” and then discounts that value to the present at the required rate of return of 12% V9= 1.25/(.12-.04) = 15.63 V0 = 15.63/(1.12)^9 = 5.64
v9 = D10/(R-G) === Vt = (Div t + 1)/(r-g) VO = V9/(1+R)^9 Schweser is correct, the value of the stock is based on the dividend in the next period ( T + 1) and once a value is found, discount back at r!
you are both right, schwesser’s answer is different due to rounding: If you take your answer and dicount it one period (ie. to period 9 which is where schwesser starts) you get v9 = 17.5/1.12 = 15.625 which rounds to 15.63 (schwesser’s value in t9) solving from there it should be the same, ie. 15.63/1.12^9 = 5.64. either way you should get a very similar answer (5.63 vs. 5.64)