A stock is not expected to pay dividends of $1.50 per share until two years from now. At that time, the dividend distribution is going to be 40 percent of net income, earnings growth is projected to be 8%, and the return on equity is expected to be 15 percent. If the required rate of return is 10 percent for the first two years and 12% thereafter, what is an approximate value of the stock today? A. $41. B. $25. C. $21. D. $50.

close to A

dreary can you explain D2 = 1.50 D3 = how do you get this? g = (1-.4)*.15 = .09 once you get D3 get P2, then discount p2 by 1.1^2 but I don’t know how to get d3… I know denomintor on p2 = .03

Agree with Dreary. I get close to A, but not exactly. P1 = D2 / (k - g) g = ROE x (1 - Div Payout) = .15 x (1 - .40) = .09 P1 = 1.50 / (.12 - .09) = 50 P0 = 50 / 1.10 = 45.45 That’s what I’m getting at least. -Stillwagon

I would go with A. Growth in dividends = 0.6*15 = 9% k = 12% P/E = 0.4/(.12-0.9) = 13.33 E in two years = 1.5/0.4 = 3.75 P = 13.33*3.75 = 50 => price in two years P today = 50*(1.1)^-2 = 41 since the question asks for “closest to” solution

Stillwagon152 Wrote: ------------------------------------------------------- > Agree with Dreary. I get close to A, but not > exactly. > > P1 = D2 / (k - g) > g = ROE x (1 - Div Payout) = .15 x (1 - .40) = > .09 > > P1 = 1.50 / (.12 - .09) = 50 > P0 = 50 / 1.10 = 45.45 > > That’s what I’m getting at least. > > -Stillwagon Why are you using .12 in the denominator for P1. the required rate of return is still 10 when P1 is in effect.

Question states that required rate is 10% for first two years. P1 (price one year from now) would fall within that timeframe. D2 falls within the time frame of 12% required return, which is why I discounted the dividend at that rate. -Stillwagon

0 — d1 ---- d2 0-d1 = 10% d1-d2 = 10% d2 comes at the end of time period two. When you give out d2, your cost of capital is still 10%

I don’t know. I get $45.87, and i don’t like this question.

I bet this is pathetic question. i just did 30 questions on DDM, and got 1 wrong. never came across this sort of question.

'not expected to pay dividends of $1.50 per share until two years from now. ’ means what if I make a time scale from 0 onwards. I get a dividend of 1.5 in year 2 or year 3? Can somebody explain the dividends on time scale- 0 1 2 1.5 3 1.5* (1.08)

yes that’s correct. Do you have an answer for this?

well, if i do like that I get yours answer. But the answer is a (BSAS Q). Seems pretty ambiguous to me.

dreary, can you please explain me the cf your way. Thanks

The growth rate was given, so that’s the one to use, 0.08…but that’s where the differences show. If you assume g=0.09 $1.50 payable in year 2, so P_2 = ($1.50 *1.09)/(0.12-0.09) = $54.50 Add $1.50 dividend = $56 Discount by the 10% required rate = $46.28 * discount either by 10% or 12%, not clear which one to use, but 10% makes more sense.

Dividend growth rate is 9%, not 8% since 8% is for Earnings. It does not say n e where in the question that dividends and earnings are growing at the same rate. And for discount rate, 12% is used to get the value in two years and then 10% to discount it to the present. Using P/E here yields more precise answer than DDM.

Isn’t g the growth rate of earnings? Isn’t that how it is defined? I haven’t looked…

is A the answer?

g is growth rate earnings, just looked it up. so clearly the question is just wrong in and of itself.

Lloyd, what seems to be wrong with the question? g is a growth rate, be it dividend, earnings or n e thing else. In this particular question, g that is given is Earnings, and we use b and ROE to get the g for Dividends.