 This topic has 3 replies, 3 voices, and was last updated May217:50 pm by mikey.

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Up::13
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 isÂ closestÂ to:
 $20.65.
 $22.72.
 $23.87.
Explanation: This is essentially a twostage 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 itÂ willÂ grow at a constant rate (5%) forever.

Up::10
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:
$P=\frac{{D}_{1}}{r\u2013g}$
where
 P = price
 D_{1}= 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
$=CF8\times 1.05+\left(\frac{CF8\times 1.{05}^{2}}{0.103\u20130.05}\right)\phantom{\rule{0ex}{0ex}}=1.953125\times 1.05+\left(\frac{1.953125\times 1.{05}^{2}}{0.053}\right)\phantom{\rule{0ex}{0ex}}=2.05+40.63\phantom{\rule{0ex}{0ex}}=42.68$

Up::4
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 (1div 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).

Up::0
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 oneoff payments (i.e. when calculating CF0 to CF8). For CF9 and using the Gordon Growth Model you always use r – g.
For lastminute tips, this is pretty useful:



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