Page 21 - FINAL CFA II SLIDES JUNE 2019 DAY 7

Two-Period DDM: The value of a share of stock using the two-
period DDM is the present value of the dividends in years 1 and 2, READING 29: DISCOUNTED DIVIDEND VALUATION
plus the present value of the expected price in Year 2:
MODULE 29.1: DDM BASICS
where:
V = fundamental value
0
D = dividends expected to be received at end of Year 1
1
D = dividends expected to be received at end of Year 2
2
P = price expected upon sale at end of Year 2
2
r = required return on equity
EXAMPLE: Calculating value for a two-period DDM: Machines Unlimited shares are
expected to pay dividends of 1.55 Canadian dollars (C$) and C$1.72 at the end of each
of the next two years, respectively. The investor expects the price of the shares at the
end of this 2-year holding period to be C$42.00. The investor’s required rate of return is
14%. Calculate the current value of Machines Unlimited shares.

Multi-Period DDM: The DDM can easily be adapted to any number of holding periods by adjusting the discount factor to match the time to receipt
of each expected return. With this, the PV becomes the sum of the properly discounted values of all expected CFs (dividends and terminal value):
where:
V = fundamental value
0
D = dividends expected to be received at end of year i, i = 1 to n
i
P = price expected upon sale at end of year n
n
r = required return on equity
n = length of holding period
For example, if we extend the holding period to three years, we simply extend the formula.
EXAMPLE: Calculating value for a three-period DDM Reliable Motors shares are expected to pay dividends of $1.50, $1.60, and $1.75 at the end of each of the next
three years, respectively. The investor expects the price of the shares at the end of this 3-year holding period to be $54.00. The investor’s required rate of return is 15%.
Calculate the current value of Reliable’s shares.