Dividend Discount Model Question following, increase, average, current, amount

Bad5shah

Brandy Clark, CFA, has forecast that Aceler, In. will pay its first dividend two years from now in the amount of $1.25. For the following year she forecasts a dividend of $2.00 and expects dividends, to increase at an average rate of 7% for the foreseeable future after that. If the risk-free rate is 4.5%, the market risk premium is 7.5%, and Aceler's beta is 0.9, Clark would estimate the current value of Aceler shares as being cloest to:

A. $37
B. $39
C. $47

farrukhsadiq

Good question...

RobertA

B.) 39 dollars?


hkese Wrote:
-------------------------------------------------------
> Brandy Clark, CFA, has forecast that Aceler, In.
> will pay its first dividend two years from now in
> the amount of $1.25. For the following year she
> forecasts a dividend of $2.00 and expects
> dividends, to increase at an average rate of 7%
> for the foreseeable future after that. If the
> risk-free rate is 4.5%, the market risk premium is
> 7.5%, and Aceler's beta is 0.9, Clark would
> estimate the current value of Aceler shares as
> being cloest to:
>
> A. $37
> B. $39
> C. $47

hariRaj

I got 38.45...I hate having rounding errors!



Edited 1 time(s). Last edit at Wednesday, May 26, 2010 at 09:37PM by nickfaulkner.

cyber21

Ke = 4.5% + .9(7.5%)
Ke = 11.25%

P0 = (1.25 / 1.1125^2) + [(2 / (.1125 - .075)) / 1.1125^2]

P0 = (1.25 / 1.1125^2) + (47.06 / 1.1125^2)

P0 = $39

Siddimaula

i thought B as well, defeinitely not C.


whats the discount rate?

draz

why do you use Ke to discount it but not the rfr?

shootingstar

ok, you always use Ke to discount back in this model i remember now.

kasinkei

Schweser solution: The required rate of return on Aceler shares is 4.5 + 0.9(7.5) = 11.25%. The dividend at t = 3, $2.00, is expected to grow at. 7% for the foreseeable future so the DDM value of Aceler shares at r = 2 is 2/(0.1125 - 0.07) = 47.06. The t 11. D = 0 value df rhe shares is (47.06 + 1.25)/1.1125 2 = $39.03.


Ke represents required rate of return. I would be investing in Treasury Securities not Aceler if i wanted RFR. Since i need a higher rate to part with my money which Ke represents, it becomes the discount rate.

Mechanic

I am pretty sure there will be a question like this on the 5th.



Edited 1 time(s). Last edit at Wednesday, May 26, 2010 at 10:22PM by nickfaulkner.