# Trouble with DDM

I sailed through equity until I hit the DDM. I get the basic one year, multi-year, and gordon growth models, but the super normal/multi-stage one is jamming me up. Im hitting all the questions in the Kap qbank before I move on to the next section but Im getting almost every single one wrong.

Give me an example and I’ll walk you through it.

The key to getting the multi-stage growth models correct is to draw a time line. You’ll have to calculate the individual dividends during the high-growth periods (and discount them individually), but the final stage will always be constant growth (i.e., the Gordon growth model, GGM). Remember that the present value you get from the GGM is the value _ one period before _ the first dividend payment.

What is the significance of this part?

Can someone walk me through this problem step by step? It appears to me like there are 3 different growth rates: 3 years at 20% to be discounted back, the fourth year which is 100% of earnings through dividends, and then the GGM at the end through a constant rate of 5%.

I can be totally wrong, but isn’t it just calculating the three future div, find terminal div, then discount everything to arrive to PV of CF?

So, D0 = .4*5 = 2 D1 = 2(1.2) = 2.4 D2 = 2.88 D3 = 8.64

Find Dt = (8.64*1.05)/(.12-.05) = 129.57

Discount everything back, you get \$102.8

Year 0 1 2 3 4

E 5 6 7.2 8.64 9.07

D 2 2.4 2.88 8.64 9.07

TV 129.6

Undiscounted CFs 2.4 2.88 138.24

PV 2.14 2.29 98.39

Company Value 102.8

I hope you see the significance of what S2000 wrote above " Remember that the present value you get from the GGM is the value one period before …".

In the solution we applied GGM on the 4th year because earning increases at a constant growth rate of 5% from year 4. Hence when we applied GGM in year 4, its PV fall one year before i.e. in year 3.

Regarding S2000’s previous comment and this portion of your comment, you’re saying that you apply GGM to the year prior to the period of constant “forever” dividend growth? So even though the constant growth begins in year 4 you apply GGM to year 3?

What we’re saying is that when you use the GGM to get the present value of a series of dividend payments that start at, say, time t = 4, the present value that you get is the value at time t = _ 3 _; i.e., _ one period before _ the first dividend payment.

Thanks, after running through a few problems I see this now. Can you briefly explain the how/why of the calculation for the amount of year 3 in this particular problem?

Yeah, so, ummmm, hate to disagree with you guys, but I calculated \$99.15 for this problems solution. I don’t know why you guys are paying out 100% of the earnings as a dividend during year 3. It clearly states it does this at the END of year 3 (aka, year 4’s dividend).

edit: The way I read it, I interpret it as the third years dividend is still being paid at 40% of earnings. I do see why you guys paid it all out though. I still think my way answers the question best though.

Coming from the guy with 2054 AF points and negative AF karma…

What a zinger. Truly, my feelings are so hurt. As I type this out, I’m literally crying at my desk. Oh no, there’s tears in my coffee now. What a failure I am in life. I haven’t amounted to anything. I guess I better kill myself now.

Some fat nerd keeps downvoting every post I make, if you know anything, all the heavy hitters on this forum have negative karma - so, if anything, you’re just calling me cool.

But back on topic, at the END of year 3 implies that the fourth years dividend will be 100% of earnings. The good news is, the writers who make the exam are good enough not to write exam questions this ambiguous. Yeah, they throw traps in the questions, but they don’t mislead you like this question.

also, I present to you, exhibit A: https://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91372417

see what I mean?

All?

Haha, fair point. Hoping I’m finally done with these exams and never have to bug you again.