Discounted Dividend Valuation Reading 27

A mid-sized US company in the utilities sector with a required rate of return of 10%. Peters and her team believe that because of a recent restructuring, the company is unlikely to pay dividends for the next three years. However, the team expects XYZ to pay an annual dividend of US$1.72 per share beginning four years from now. Thereafter, the dividend is expected to grow indefinitely at 4% even though the current price implies a growth rate of 6% during this same period.

If the team uses the dividend discount model, the current intrinsic value of Company XYZ stock would be closest to :

  1. US$19.58.
  2. US$20.36.
  3. US$21.54.

C is correct. The current value of XYZ stock would be calculated as follows:
V0 = [P3/(1 + r)3], where P3 = D4/(r – g).

Given D4 = 1.72, r = 10%, and g = 4%,
V0 = [1.72/(0.10 – 0.04)]/(1.10)3 = US$21.54.

My question here is, if calculate V4=D5/(r-g) = 29.813 then discount it 4 periods instead of 3, I get a different answer which is B, shouldn’t both methods lead to one answer?


The second method ignores the dividend you get at time t = 4.

is this a level 2 question?

yes it is