DDM Schweser Question

The following data pertains to a firm’s common stock: - no dividends for 2 years - dividend 3 years from today is expected to be 1$ /sh - dividends are expected to grow at a 7% rate in perpetuity from that point forward If an investor requires a 17% return on this investment, how much will the investor be willing to pay for this stock now? a) $6.24 b) $7.31 c) $8.26 d) $10.00 I’ll post the answer shortly, dea


The answer is B. The value of the perpetuity is $10 at the beginning of year 3 (1/(.17-.1)). That needs to be discounted back two years at 17%, which results in $7.31.

The answer is B. P2 = D3/Ke-g = $10 P0 = P2/(1+ke)^2 = $7.31 I incorrectly discounted P2 3 periods which is $6.24.

Its the same priciple here as in the other TVM problem you posted . the dividend is for t=3. So price corresponds to t=2. So you discount back 2 periods not three.