Hi guys,
Why is it that when using the dividend dicount model, sometimes you multiply the dividend by (1+g) before dividing by price and other times you just divide by price without multiplying by (1+g)?
Specifically in reference to Schweser Concept Checkers (9 and 15) for Reading 37.
Would really appreciate help guys.
Thanks!
The key is to remember that the price of a share of common stock (or of a bond, for that matter) is the present value of expected FUTURE cash flows. The Constant Growth Formula is simply the formula for the present valueof a growing perpetuity: PV at time “t” = Cash Flow at time “t+1”/(r-g). In this case, the cash flow is the dividend.
So if you are given the most recent dividend, you need to convert it by multiplying by “1+g” to get the next expected dividend. If you are given the next exected dividend, you don;t need to multiply by “1+g”.
Hi Kapie
Its simple, If you have given in the question D0 dividend for the present year you need to convert this into D1 dividiend for the next year by multiplying (1 + G ). And hence if D1 is given you not need to multiply by ( 1+ G ) today.
Thanks guys. Makes sense now.
Not reading the question thoroughly sure does cause problems.
I’ll have to work on that.