DDM

CFA Level I Equities
#1

Hi all,

I have a question regarding the DDM.

Here is is the problem: X corporation is expected to pay a dividend of 2.25 per share this year. Sales and profit for X will grow at 20% for 2 years and then at 5 % after the 2 years forever. Dividend sales growth are expected to be equal. If X shareholders requierea 15 % return, the per share value of X common stock based onthe dividend discount model is closest to:

22.75

26.00

28.50

So these are the steps I am following:

I project the dividend growth for 2 years then forever at 5 and discount it back I get 32.40.Using the D3/k-g, that’s for the dividend.

Here is where I get confused: P0=2.25/1.15+2.70/1.15^2+32.40/1.15^2=28.50

why are we discounting again the dividend, isn’t that what I just did in the first forumula?

If you could please explain what’s the logic to find out the PV? thank you in advance!

#2

Draw a timeline for these problems.

When you discount D3 continuous dividend at r-g you get P2 (Price at year 2).

you then need to get the PV of the P2 to year 0.

that is what you are doing when you do 32.40 / 1.15^2.

#3

Hi CPK123, if I only discount: 32.40 / 1.15^2. I don’t get to 28.50 which is the correct answer.

They discount (2.55/1.15+ 2.70/1.5^2 ) + 32.40 / 1.15^2. Which equals 28.50

That’s where I am confused. I would have discounted this only: 32.40 / 1.15^2…

Does it make sense?

#4

nope.that means you missed the dividends paid in year 1 and year 2 completely.

and i am also seeing that none of the answers match.

I am getting

2.7 / 1.15 + (3.24+34.02)/1.15^2 = 30.52

#5

Because you are discounting from 2.70 which is the second dividend growth period. To get to their answer 28.50 you should start a step back and discount from 2.2, not 2.70

So basically you project forward using K-G and then backwards or PV with K, is that right?

Thank you

#6

sorry I meant 2.25