# How to value a non dividend paying stock

here is a concern i have in valuing a non dividend paying stock which starts paying dividends at some point in future. let us assume a company starts paying dividend in year 5 let us say \$1 which grows at 5% and the required rate is 10% in this case am i supposed to calculate V4 or V5. Schweser says calculate V4 and uses V4 = 1/ (.10 - .05) and then discounts it to V0 but i think we should calculate V5 as V5 = 1 * (1.05) / (.10 - .05) and discount it to V0 any thoughts

Should be Year 4 , not Year 5. Look at Level I readings for Dividend Growth Model . Price is calculated based on the expected Dividend in the next year , not the current Dividend

hi janaki which is exactly what i used. i am using \$1 * 1.05 which is the dividend in year 6 to calculate the value of V5 My question is why are they using V4 instead of V5 when the growth of the dividends start from year 6. Until the end of year 4 there are no dividends. in year 5 they pay \$1 which then continues to grow at 5%. the fact that they are calculating V4 instead of V5 is bothering me. i totally agree with you that the value is based on next year dividend. but here dividend value is not my concern. my concern is the year they are using based on the question they asked.

Year 5 dividend is based on Value in Year 4 . Why do you say Year 6 , when the question says Year 5 ? Where do you get the 6 from? I don’t see it in your question?

i say year 6 because in year 5 the company pays 1\$ which is the first dividend and then from then on the growth is 5%. i am under the impression that the terminal value is calculated when the growth rate starts. in this case even though the first dividend is paid in year 5 the growth of the dividend at a sustained rate starts from the following year. so i am confused as to why they chose year 4 and not year 5 as the terminal year for the calculation

I wouldn’t do too much analysis . I can always argue that the company was growing at 5% all along , just not paying dividends.

Ravali is right, that is the terminal value in Year 5.

The CFAI book shows the same exact problem on page 333 example 15 of reading 40 in equity

Both will provide the same answers. Generally, we use the year 5 formula. V5 = 1 * (1.05) / (.10 - .05) and discount it to V0

idreesz Wrote: ------------------------------------------------------- > Both will provide the same answers. > > Generally, we use the year 5 formula. > > V5 = 1 * (1.05) / (.10 - .05) > > and discount it to V0 V4 = 1/ (.10 - .05) = 20 = discount to V0 = 20/1.4641 = 13.6603 V5 = 1 * (1.05) / (.10 - .05) = 21 = discount to V0 = 21/1.6105 = 13.0393 It’s safe to say on the exam, they’ll probably ask for an approx. answer. But if the options are pretty close like option A - 13.04, B - 13.67, and C - 13.50, then you’ll get it wrong if you use V5 info. You use V4 because that’s the earliest year you can value with the info already provided. In year 4, the next year dividend is already provided (V5 Div = \$1).

By using the 1.05 (dividend in yr 6), you are ignoring the cash flow in yr 5. The difference is not huge because of the time value of money but it is technically different. It is logical to think that of what a company is worth in year 4 because there is an expected dividend in year 5 and then take the PV of this. Thats my thoughts at least. I can see the thought process both ways but it seems more logical to find the value of the firm in yr 4 to me.

thanks guys. i guess as jayce was pointing it out, i was missing the year 5 Cash flow. I guess i can get the v5 and add the \$1 and then proceed to pv. the geometric series inherent in the question made me go for V5. i did not try with the \$1 added but i will definitely give it a try and see how it goes. af rocks.