Hey all, confused on a schweser q. (reading 39, q16). Basically the company won’t pay a dividend for ten years, at which point it will pay $1.25. I multiplied this by the long term growth rate to get ‘D1’, worked out D1 / (r - g) then discounted it back 10 periods. Schweser used the dividend given in the question as D1 then discounted the answer back by 9 periods. Any ideas why? Thanks all
Is the dividend in year 10 expected to be paid in perpetuity? If so, then it’s just like the terminal value of a “regular” dividend discount model.
In your calculation you just left out the first 1.25 dividend. So if you do your calculations plus 1.25/(1+r)^9 you should get the same answer.
You actually received that Div so theres no reason you should have left it out of the equation.
The solution you’ve provided is for the treatment of perpetuity. When a company keeps on paying the same amount of dividend without any growth onwards we use this method. Try posting the complete question here.
Hey guys thanks for the advice. If I do it the way I originally tried, and add the PV of the $1.25 dividend, I get the answer. More specifics of the question: Dividend of $1.25 in 10yrs followed by constant growth of 4% Required return = 12%. Schweser did 1.25 / (.12 - .04) then discounted that by nine periods.
that is correct.
when the 10th year dividend is discounted by (r-g) you end up with the price P9.
D1/(r-g) = P0
D10 / (r-g) = P9.
Draw a timeline.
So you now need to discount that back 9 periods.
P9 = D10/k-g
Discounting P9 for 9 years can get you P0
Alternatively
P10 = D11/(k-g)
P10 + D10 and then discounting them back 10 years can get you P0