- This topic has 3 replies, 3 voices, and was last updated May-217:50 pm by
.
-
Posts
-
-
Up13
Anyone know how to do this for the Gordon growth model?
A stock that currently does not pay a dividend is expected to pay its first dividend of $1.00 five years from today. Thereafter, the dividend is expected to grow at an annual rate of 25% for the next three years and then grow at a constant rate of 5% per year thereafter. The required rate of return is 10.3%. The value of the stock today is closest to:
- $20.65.
- $22.72.
- $23.87.
Explanation: This is essentially a two-stage dividend discount model (DDM) problem. Discounting all future cash flows, we get:
Note that the constant growth formula can be applied to dividend 8 (1.253) because it will grow at a constant rate (5%) forever.
-
Up11
I got A as my answer.
- CF0 = 0
- CF1 = 0
- CF2 = 0
- CF3 = 0
- CF4 = 0
- CF5 = 1
- CF6 = 1*(1.25) = 1.25
- CF7 = 1*(1.25)2 = 1.5625
- CF8 = 1*(1.25)3 = 1.953125
- CF9 = 42.68 (see explanation below)
- I = 10.3%
- NPV = $20.65
CF9 = dividend + price by Gordon Growth Model
Gordon Growth Model formula:
where
- P = price
- D1= value of next year’s dividend
- r= required rate of return
- g=constant rate of growth
So calculating CF9
CF9 = dividend + price by Gordon Growth Model
-
Up4
I just straight up struggle at these DDM questions. I am constantly wondering if I have to take the req rate of return as the denominator versus the constant growth at just D/expected rate of return – growth. You get growth at times by taking ROE * RR (1-div payout). So much to remember and I STILL get the questions wrong. Any last minute tips on this? Figure I should focus on stronger areas and not get bogged down here (though I know its very important).
-
Up0
The required rate of return (10.3% in this thread’s example) is used when discounting to present value (since 10.3% a year is what time is worth to you).
That’s for one-off payments (i.e. when calculating CF0 to CF8). For CF9 and using the Gordon Growth Model you always use r – g.
For last-minute tips, this is pretty useful:
-
-
- You must be logged in to reply to this topic.