DDM and when to multiply dividend by growth rate

CFA Level I Equities
#1

I am having difficultly figuring out when I need to multiply the dividend by the growth rate and when I don’t need to. Naturally, there is a reason but I cannot seem to figure it out.

For example:

What is the price of the following stock?

I.) Last years dividend was $1.62.

II.) The dividend is expected to grow at 12% for three years.

III.) The growth rate of dividends after three years is expected to stabilize at 4%.

IV.) The required return for XYZ’s common stock is 15%.

Which of the following statements about XYZ’s stock is least accurate?

A) XYZ’s stock is currently worth $17.46.

The dividends for years 1, 2, and 3

($1.62)(1.12) = $1.81;

($1.81)(1.12) = $2.03;

($2.03)(1.12) = $2.27.

At the end of year two the stock should sell for $2.27 / (0.15 - 0.04) = $20.64.

The stock should sell currently for ($20.64 + $2.03) / (1.15)^2 + ($1.81) / (1.15) = $18.71.

For this problem you do not multiply the dividend by the growth rate.

A company has EPS of $5 and pays out 40% in dividends. The earnings growth rate for

the next three years is 20%. At the end of the third year the company will pay out 100% of earnings in

dividends and earnings will increase at an annual rate of 5%. If a 12% rate of return is required, the

value of the company is:

A) $102.80.

B) $92.92.

C) $55.69.

D0 = (0.4)(5) = 2

D1 = (2)(1.2) = 2.40

D2 = (2.4)(1.2) = 2.88

D3 = 5(1.2)^3 = 8.64

g after year three will be 5%;

D4 = 8.64 *1.05 = 9.07

For this problem you multiply by the growth rate.

Help!

#2

Multiply by the divident growth rate when you do not have the dividend in t+1 to compute a terminal value. In general, for a terminal value in time, t, you will need to the dividend in time, t+1.

For GGM, if you want V(0), and you have only D(0), then multiple by (1+g) to get D(1).

If you are using two stage, and you need to find V(0) and you have D(1),D(2),…,D(n), and need to find V(n) to complete the terminal vvaluation, you would use D(n)(1+g) to find D(n+1). Use D(n+1) and divide by (r-g) to give V(n).

#3

Thank you for the reply. I understand that you must find value N by using dividiend N+1, but like for the aforementioned problems, I was given dividend N but one required N+1 and the other other required N and I don’t understand why, if that makes any sense. Thanks.

#4

It will require n if there is not divident growth rate (because g=0).

In that case the GGM is a perpetuity and is as follows:

V=D(1+g)/(r-g) = D(1+0)/(r-0) = D/r

#5

Both problems seem to have an incorrect solution, where are you extracting this from?

#6

I guess to make my question a bit broader and easier to understand, when do you multiply the dividend by the growth rate, and when do you not?

#7

it depends on what year of dividend you are given relative to what year you are trying to value the stock in.

my first post should answer that question

#8

I see what you are saying, but in the context of a problem I’m having a tough time figuring out when I need to find the t+1 dividend or not.

#9

I see what you are saying, but in the context of a problem I’m having a tough time figuring out when I need to find the t+1 dividend or not.

#10

I see what you are saying, but in the context of a problem I’m having a tough time figuring out when I need to find the t+1 dividend or not.

#11

I see what you are saying, but in the context of a problem I’m having a tough time figuring out when I need to find the t+1 dividend or not.