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Unformatted text preview: eriods
of time. Implications of the model
1. Stock price will increase:
1. If investors expect a large dividend K decreases g increases 2. Stock price is expected to grow at the same
rate as dividends
When the stock is priced to equal its intrinsic value: E(R) = D1 / P0 + g E(R) = K Disadvantages of the DDM
Model can’t be applied to firms who don’t
Model can’t be applied when g>K
Can’t handle firms with variable dividend
A share of stock will pay a dividend of $3.0
one year from now, with dividend growth of
5% thereafter. The stock is correctly priced at
$30 today in accordance with constant DDM.
If the required return is 15%, what should the
value of the stock be 2 years from now?
value First we need to find the dividends in year 3:
Dividend in year 3 = $3 x (1.05) 2 = $3.31
The price in year two is based on the expected
dividend paid in year 3 and the dividend growth
P2 = D3/ ( k-g) = 3.31 / ( 0.15 – 0.05) =
$33.10 What happens when dividend growth is
Step Find dividends over the variable growth
period, using the variable growth rate.
period, Step 2: Find the price of the stock in period t
(after the variable growth period) using
the normal/constant growth rate (g).
the Step 3: Discount all cash flows back to the
present to find V0.
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