Supernormal Growth DDM

A stock that currently does not pay a dividend is expected to pay its first dividend 5 years from now of \$1.00. Thereafter, the dividend is expected to grow at an annual rate of 25% for the next three years and then grow at a constant rate of 5% per year thereafter. The required rate of return is 10.3%. What is the value of the stock today? a. 20.65 b. 20.95 c. 22.72 d. 23.87 I’ve tried to answer this question using the growth model in the schweser book, yet still cant seem to get it correct. Please help!

i get about 20.03. there must be some mistakes in calculation.

Are you Present Valuing the dividends from 5 years into the future?

i got the price 5 years from now. then get the PV of that price.

Are you including the first dividend of \$1 and are you using the NPV function on the BA II plus to PV the dividends and the Stock Price?

Answer is A. D5 = 1 D6 = 1.25 D7 = 1.5625 D8 = 1.9531 D9 = 2.0508 D10 = 2.1533 P9 = D10/(r-g) = 2.1533/(.103-.05) = 40.6283 Discount D5,D6,D7,D8,D9 + P9 to get 20.6467

A. CF0-CF4 = 0 CF5 - 1 CF6 - 1.25 CF7 - 1.56 CF8- 1.953+38.67 PRICE IN YR 8 = 38.67 = DIV IN YR 9/ k- g NPV = 20.63

This is what I’m doing: Calculating the \$ amount of dividends per year D0 = 1 D1 = 1(1.25) = 1.25 D2 = 1.25(1.25) = 1.56 D3 = 1.56(1.25)= 1.95 D4 = 1.95(1.05) = 2.05 Calculating Stock Price 2.05/(.103-.05) = 38.68 Using the NPV function on BA II PLUS, and inputting the cash flows as follows: CF 5 = 1 CF 6 = 1.25 CF 7 = 1.56 CF 8 = 1.95 CF 9 = 2.05 + 38.68 CPT NPV 19.84 Is my method correct?

the price you calculate is for year 8 Price in year 8 = div in year 9 / K - G so that price should be in CF 8 not 9

I think for the exam the best strategy would be to just ignore the question, because even if you know what to do, if you’re not a calculator-wizard, you’ll probably get th wrong answer

use the TVM chart, the time line, it’s very easy and straightforward once you put it all on the line…

So essentially, I don’t inlude the dividend that arises after normal growth is achieved?

well the most challenging part of this question is the wording. i don’t think the actual discounting trips anyone up, it’s just knowing how to understand when to start discounting \$1.00 and \$1.25… as IVC said, it could be easier to set up a timeline , oh well

beingthatguy’s method is the one that worked for me, FWIW

Hey, Late to the game. I realized i need to enter this stuff in my calculator to have a chance @ doing it fast. I have no trouble when finding the IRR on these types of CF problems, what’s the key combo to get the NPV. ( {IRR}{CPT} ) When I hit npv it prompts me to enter I, what’s going on, my manual’s at home. Thanks.

Heres the answer from schweser. I just went over it on Exam 2 AM #96 This is essentially a two-stage dividend discount model (DDM) problem. Discounting all future cash flows, we get: Note that the constant growth formula can be applied to dividend 8 (1.253) because it will grow at a constant rate (5%) forever. It is preferable to do this with the right keystrokes on the calculator but it is a bit tricky. Since the first non-zero cash flow occurs in year 5, we have to communicate this information to the calculator correctly to get the indicated solution. Using the CF function, the sequence of keystrokes would be (note that cash flow frequencies of 1, for F2 through F4, are omitted for simplicity): CF0 = 0; CF1 = 0, F1 = 4; CF2 = 1.00; CF3 = 1.25; CF4 = 1.5625 + 36.85 = 38.41; I = 10.3; CPT ¨ NPV = \$20.647. When we input the first dividend as CF2 = 1.00, we are telling the calculator that this is really received in the fifth year and it is then discounted correctly. Note that CF4 is made up of two components: the dividend that is paid at the end of year 7 = (1.25)2 = 1.5625 plus the present value of the constantly growing (at 5%) perpetuity = These two can be added since they are effectively received at the same point in time. Hope that helps.

priehl Wrote: ------------------------------------------------------- > > When I hit npv it prompts me to enter I, what’s > going on, my manual’s at home. > > Thanks. You need an I to get a NPV. Or am I misinterpretting the question?

WOW… I don’t know how to explain myself, that’s so obvious, it should have never even been a question. Thanks for the help

One more thing hopefully less stupid. if 5 years from today they pay a dividend, then it’s supposed to grow @ 25% for the next 3 years. Doesn’t this mean that it should have another growth period! D5 = 1 D6 = 1.25 D7 = 1.5625 D8 = 1.9531 Giving us D8 as the final dividend to add to the constant growth perpetuity part of the equation? The question says “A stock that currently does not pay a dividend is expected to pay its first dividend 5 years from now of \$1.00. Thereafter, the dividend is expected to grow at an annual rate of 25% for the next three years and then grow at a constant rate of 5% per year thereafter…” It’s the next 3 years after part that I’m badly missing… Thanks for the help.

For some reason when I posted the answer the formula they provided didn’t show up. I just typed it up. Po = (1.00/(1.1.03^5)) + (1.25/(1.103^6)) + ((1.25^2)/(1.103^7)) + [((1.25^3)/(.103-.05)(1.103^7))] = \$20.647 Note that the constant growth formula can be applied to dividend 8 (1.253) because it will grow at a constant rate (5%) forever. Hope that helps out Priehl