Schweser Rd 42
Concept Checker:
#1 ) It’s a standard multistage RI model which assumes persistent RI after five years of $11.25. I understand the problem but am confused on the discounting periods. The answer has the continuing RI or terminal value discounted from t=5 (or (1+r)^5)…WHY IS IT NOT 4-PERIODS (or T-1 which would be (1+r)^4) ???
#2 ) The question gives a stock price that was priced with an assumption of continuing residual income at a persistent level forever, and asks which of the 3 other related continuing residual income assumptions would result in a stock price that is lower than the given $68 share price.
I understand why any assumption with a persistence factor equal to or greater than 0 but less than 1 would cause a lower stock price but how can you assume that the 4th assumption (CRI leveling off at a long-run industry average will result in a lower stock price ??? WIthout having specific numbers to verify, how do you know that the long-run industry average isn’t higher than the assumed level in perpetuity that was used to price the stock originally (which would result in a higher price, not lower)??
Please help, and thanks in advance! Regards