Page 28 - FINAL CFA II SLIDES JUNE 2019 DAY 7

LOS 29.l: Calculate and interpret the value of common READING 29: DISCOUNTED DIVIDEND VALUATION
shares using the two-stage DDM, the H-model, and the
three-stage DDM.
MODULE 29.3: MULTIPERIOD MODELS
Valuation Using the Two-Stage Model: Assumes that the firm will enjoy an initial period of high
growth, followed by a mature or stable period in which growth will be lower but sustainable:
where: EXAMPLE: Calculating value with a two-stage DDM: SIR currently pays
g = short-term growth rate a dividend of $1.00. An analyst forecasts growth of 10% for the next three
S
g = long-term growth rate years, followed by 4% growth in perpetuity thereafter. The required return
L
r = required return is 12%. Calculate the current value per share.
n = length of high growth period
The forecasted dividends are shown below:

Constant growth at 4% begins after the third year, and we can employ
the DDM to determine the value of the stock at time t = 3. Accordingly:

Financial calculator: CF0 = 0; C01 = 1.10; C02 = 1.21; C03 =
18.63; I = 12; CPT → NPV = 15.21.
Exactly like the 3-period DDM earlier: we know the dividends in years 1, 2, and 3, the terminal value in Year 3, and the discount rate. The cash flows are:

EXAMPLE: Valuing a non-dividend-paying stock: AD is a new and currently pays no
dividends. It recently reported EPS of $1.50 (g = 15%, next 4 years). Beginning in Year
5, AD is will distribute 20% of its earnings as dividends and to have a constant growth
rate of 5%. The required rate of return is 12%. Calculate the value of AD shares today.

Answer:
1. Forecast the earnings in Year 5.
Value of a firm that currently does not pay dividends? 2. Calculate the dividends in Year 5
as 20% of Year 5 earnings.
The PV of the terminal value computed at the point in time at 3. Apply GGM to the Year 5 dividend
which dividends are projected to start. gives us an estimate of the
terminal value in Year 4.
4. The terminal value discounted
back four years is the current
value of the stock.