# Stock Valuation Problem (DDM)

Brandy Clark, CFA, has forecast that Aceler Inc. will pay its first dividend two years from now in the amount of \$1.25. For the following year she forecasts a dividend of \$2.00 and expects dividends to increase at an average rate of 7% for the foreseeable future after that. If the risk-free rate is 4.5%, the market risk premium is 7.5%, and Aceler’s beta is .9, she would estimate the current value of Aceler shares as being closest to: A) \$809 B) \$39 C) \$35 D) \$31 I’m getting a different answer than any of these choices and am not really understanding the logic of the answer explanation. Can someone solve this and explain it?

D(t=2) = 1.25 D(t=3) = 2.00 D(t=4) = 2(1.07) = 2.14 k = .045 + .9(.075) = .1125 PV (t=3) = 2.14/(.1125-.07) = 50.35 PV (t=0) = 1.25/(1.07)^2 + 2/(1.07)^3 + 50.35/(1.07)^3 = 43.82 This is my method, which is wrong according to Schweser. The answer is B and I don’t have the book in front of me right now but when I briefly looked at the explanation it didn’t make sense to me.

b) ~\$39 DDM method stock price = 0/1.1125 + 1.25/1.1125^2 + 2.00/1.1125^3 + (2.14/(0.1125-0.07))/1.1125^3 in year one ~ no dividend in year two ~ \$1.25 dividend discounted to year zero by cost of capital (k = 4.5 +0.9(7.5%)) in year three ~ \$2.00 dividend discou" " in year four ~ \$2.14 dividend discounted as an perpetual annuity by its growth rate (k-g) then discounted to year zero

oh god damn! i need to use k in the denominator duhhh… Nevermind when I redo the problem using that discount rate (11.25%) I get \$39.03, the correct answer.