dividend discount model management, expected, question, following, discount

JustasS

from schweser p. 225 number 16 portfolio management book

BTW, number 17 is similar to my question.


assume that a stock is expected to pay dividends at the end of year 1 and year 2 of 1.25 and 1.56. dividends are expected to grow at a 5% rate thereafter. assuming that ke is 11%, the value of the stock is closest to which of the following?

a. 22.3
b. 23.42
c. 24.55



answer: (1.25/1.1) + [1.56 / (.11 - .05)] / 1.1 = 24.55

why not: (1.25/1.1) + [1.56 / (.11 - .05)] / 1.1^2 = 22.26

year 2 dividend should be discounted by 1.1^2 right?

draz

remember that the terminal value is a perpituity, so it gives you a pv for period 1, not period 2. thus, once you have that value, you need to discount it by an additional one period (i.e. 1.1 not 1.1^2).

Beatnik

Check the search function this question has been answered before - i.e. from the same Schweser reading and same questions