Hi Guys, I am really struggling with trying to decipher when I should be using (1+k)^n as the denomiator and (k-g). This is when both the growth rate and the required rate is shown. Surely there should be no difference, but somehow there is. Thanks
When you’re discounting _ a single cash flow _ n periods from today, with a discount rate of k per period, you divide by (1 + k)^n.
When you’re discounting _ a series of cash flows _ that meet these criteria:
- They start 1 period from today
- They continue forever
- They grow at a rate of g per period
- The discount rate is k per period
you discount the first cash flow by k − g.
When dealing with GGM, definitely you have to use r - g, and (1+r)^n under DDM.
When you have multistage DDM, then you have to grow your dividend period after period, discount it at (1+r)^n, then at the last period, you need to find the terminal value which is mostly (D1/r-g)/(1+r)^n
So just calm down and follow the processes duely.
You will be fine.