Page 30 - FINAL CFA II SLIDES JUNE 2019 DAY 7

EXAMPLE: Three-stage growth model with linear growth READING 29: DISCOUNTED DIVIDEND VALUATION
decline in stage 2: As an analyst, you have gathered the
following information on a company you are tracking.
MODULE 29.3: MULTIPERIOD MODELS
The current annual dividend is $0.75. Dividends are expected to grow at a rate of 12% over the next three
years, decline linearly to 4% over the next six years, and then remain at a long-term equilibrium growth rate
of 4% in perpetuity. The required return is 9%. Calculate the value of the company.

Answer: Let’s start by valuing the last two stages using the H-model. We know that:

It follows that:

Fin Calc:
2
CF0 = 0; C01 = D = $0.75(1.12) = $0.84; C02 = D = $0.75(1.12) = $0.9408; and C03 = D + V = $1.0537 + $26.9747 = $28.0284; I = 9;
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2
3
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CPT → NPV = 23.2056 (price of the stock)
Valuation Models Using Spreadsheets DDM models are ideally suited to being solved with spreadsheet software. A spreadsheet allows the analyst to
easily calculate values based on models with many stages, growth rates, and required rates of return.
LOS 29.m: Estimate a required return based on any DDM, including the Gordon growth model and the H-model.

EXAMPLE: Calculating expected return with the Gordon growth model. Smyth & Weston Explosives’ stock is expected to pay a dividend of $1.60,
has a current price of $40.00, and has a projected growth rate of 9%. Calculate S&W’s implied required return.

The H-model can
be rewritten in
terms of r:

EXAMPLE: Solving for expected return with the H-model: BF., just paid a current dividend of $0.75, which has been growing at a rate of 10%. This
growth rate is expected to decline to 5% over the next five years and then remain at 5% indefinitely. Calculate the implied required return for Beluga
based on the current price of $30.00.