Does any else have a problem with the following questions in Schweser 2010 book 4? Page 225 Questions 16, 17 and 26. I have a problem with the solutions provided. 16. Assume that a stock is expected to pay dividends at the end of year 1 and year 2 of $1.25 and $1.56 respectively. Dividends are expected to grow at the rate of 5% thereafter. Assuming that Ke is 11%, the value of the stock is closest to which of the following? A. $22.3 B. $23.42 C. $24.55 17 and 26 are also similar, check them out and lemme hav your thoughts please
hmm… d1=1.25 d2=1.56 d3+=1.56*1.05=1.638… PV=d1+d2+[d3/(Ke-g)]/(1+Ke)^2=24.9542 ?
Well, as you might have noticed, your answer is not one of the choices. I would have thought you’d discount d2 by (1+ke)^2 and d3 by (1+ke)^3 though. Let’s hope someone can really get a handle on this…
ans is 24.55 CF1=1.25 P2 = 1.56*1.05/(0.11-0.05)=27.3 CF2=1.56+27.3=28.86 Use CF function, I=11% -> 24.55 Choice C
Q#16 Look, Lets work with respect to a timeline so we get a better understanding. WE MUST REMEMBER THAT we have to discount the cash flows to the time0 (T0) today. ----------------------------------------------------------------------------------------------------------------- T1 - Dividend is = 1.25 PV of Div1 is simple = 1.25 / 1.11 = 1.1261 ----------------------------------------------------------------------------------------------------------------- Now from End of T1 to T2 firm is going to pay Dividend of 1.56 T1 >----------> T2 You want to calculate what is the present value of this constant growth dividend stream at the end of T1 so At the End of T1 PV of the D2 Stream is Div 2 = 1.56 r = 11% g = 5% PV of D2 Constant growth Stream at the end of T1 is 1.56/.11 - .05 = 26 (This is PV of the future constant stream at around end of T1). So in order to get it to time0 (T0) we will discount it which is = 26 / 1.11 = 23.423 -------------------------------------------------------------------------------------------------------------- Adding 1.1261 + 23.423 = 24.5491 or 24.55 which is also the answer Other questions are done the same way I think the only problem is that with supernormal growth schweser uses a bit different method then from some traditional finance books we are used to.
Agree with cpk123 PV for yr 1 = 1.13, PV for yr 2 = (1.56+27.3)*0.8116= 23.42 Total PV = 24.55 Ans is C
OMG… how can i do such an idiotic mistake?! answer c is correct. i didnt PV the d1 and d2 CFs in my earlier post…
Thanks guys;cpk123 and supersunny…gr8…i got it now…and i have the benefit of understanding it from two different perspectives…good…thanks y’all