What is the correct answer to this question?

CFA Level I Equities
#1

Next year’s dividend is expect to be $2, g = .07 and k = .12. What is the stock’s intrinsic value?

Is it 2/.05 = 40?

Or is it 40/1.12 = 35.7?

#2

V(t) = D1/r-g so it is 2/.05 =40 Apologies for the subscripts

#3

The dividend discount model is D1/(K-G) so 40 would be the correct answer.

#4

C3Po, you beat me by a minute. Thanks for posting the response.

#5

Why would you not discount next year’s dividend of 2 dollars since it is coming in the next year?

#6

i have doubt as well they have give k not g . k usually stands for payout ratio which is forecastdividend/forcast earning so how can u use ddm model in this ???

#7

srry i meant r not g …

#8

k is the return on equity. usual terminology for the payout ratio is b.

#9

My 2 cents is for you to be very careful with these dividend discount model questions. Unlike the question you posted, the CFA curriculum questions almost always try to trick you by giving you D0 (dividend at time zero) instead of D1, so you have to convert D0 to D1 (next year’s dividend) before plugging it into the formula. The worst kind of questions are when you have to also come up with K (RFR + B(ERmkt - RFR)) and G (RRxROE) and on top of that they give you D0