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Chapter 3 - Discounted Dividend Valuation

Using a Multi-Stage Dividend Discount Model to Value Common Stock

Example for Slides 5-6
ASSUMPTIONS
0

D
P
r

\$1.00

\$1.05

\$1.10
\$20.00

10.00%

OUTPUT - Valuing Common Stock using a DDM

PV of the Dividends
\$0.91
\$0.87
PV of the Expected Stock Price
PV of the Total Dividend Stream
PV of the Expected Price

\$0.83
\$15.03
\$2.60
\$15.03

\$17.63

D equals
P equals
r equals

dividend per share

expected price per share
required return on equity

Chapter 3 - Discounted Dividend Valuation

Using the CAPM & Gordon Growth Model to Value Common and Preferred Stock and derivin
Example for Slides 8-11, 13

ASSUMPTIONS
Risk-free rate
Beta
Current dividend
Dividend growth rate
Current Stock Price

3.0%
6.0%
1.20
\$2.00
5.0%
\$24.00

OUTPUT - CAPM Required Return & Common Stock Valuation

CAPM Required Return
10.20%
Stock Value
\$40.38
Valuation
Undervalued

OUTPUT - Deriving an Implied Growth Rate

Implied dividend growth rate

OUTPUT - Deriving an Implied Required Return

Dividend Yield
Capital gain (dividend growth rate)
Total implied required return

OUTPUT - Preferred Stock Valuation

Stock Value if Preferred
assumes preferred is noncallable with a dividend
growth rate equal to zero

1.72%

8.75%
5.00%
13.75%

\$19.61

ferred Stock and deriving an implied growth rate and required return

Chapter 3 - Discounted Dividend Valuation

Calculating the PVGO and the component of the P/E ratio due to PVGO
Example for Slides 16-18

ASSUMPTIONS

Stock price
Expected earnings
Required return on stock

\$80.00
\$5.00
10%

OUTPUT - Calculating the PVGO

No-growth value
PVGO
percent of value due to PVGO

\$50.00
\$30.00
37.5%

OUTPUT - Calculating the component of the P/E ratio due to the PVGO

P/E firm
P/E PVGO

16.0
6.0

Chapter 3 - Discounted Dividend Valuation

Calculating the justified leading and trailing P/Es based on fundamentals using the Gordon
Example for Slides 21-23

ASSUMPTIONS

Stock price
Trailing earnings per share
Current dividends per share
Dividend growth rate
Required return on stock

\$50.00
\$4.00
\$1.60
5.0%
9.0%

0.40
10.0

Actual P/E

10.5
12.5
Overvalued

Chapter 3 - Discounted Dividend Valuation

Calculating the stock value using the General 2-stage DDM
Example for Slides 27-31

ASSUMPTIONS - Calculating the PV of the dividend stream and the stock value using the G
D0
g1
r
g2
\$2.00
15%
10%
4%

OUTPUT - Calculating the PV of the dividend stream and the stock value using the Gordon
t
1
2
3
3
D1
D2
D3
D4
P4
\$2.30
\$2.65
\$3.04
\$3.16
\$52.72
PV(D1)
\$2.09
Value of Stock

PV(D2)
\$2.19

PV(D3)
\$2.29

PV(P3)
\$39.61

\$46.17

ADDITIONAL ASSUMPTIONS - Calculating the PV of the dividend stream and the stock valu
Projected dividend payout ratio in year 4
60%
Projected trailing P/E ratio in year 4
13.0

OUTPUT - Calculating the PV of the dividend stream and the stock value using the P/E rati
Projected earnings in year 4
\$5.27
Projected stock price in year 4
\$68.54
Present value of projected year 4 stock price & dividend
\$48.97
Value of Stock

\$55.54

k value using the Gordon Growth Model for the terminal value

e using the Gordon Growth Model for the terminal value

and the stock value using the P/E ratio for the terminal value

Chapter 3 - Discounted Dividend Valuation

Calculating the stock value using the 2-stage H-Model
Example for Slides 33-35

ASSUMPTIONS
Current dividend
gs
gL
H
Required return on stock
Current Stock Price

\$3.00
20%
6%
5
10%
\$120

OUTPUT - Calculating the stock value using the H-Model

Value of normal growth
79.50
Value of high growth
52.50
Value of Stock
132.00
Undervalued

60.2% of total stock value

39.8% of total stock value

OUTPUT - Calculating the required return implied by the current stock price
Total implied required return
10.40%

total stock value

total stock value

ock price

Chapter 3 - Discounted Dividend Valuation

Calculating the stock value using the 3-stage DDM, using the H-Model for the last 2
Example for Slides 37-38

ASSUMPTIONS - assumes duration of 1st stage is 2 years

Current dividend
\$1.00
Required return on stock
10%
Current Stock Price
\$50
H-Model Inputs
gs
20%
gL
5%
H

OUTPUT - Calculating the stock value using the 3-stage DDM, using the H-Model fo
PV0
Value
D1

\$1.20

\$1.09

D2

\$1.44

\$1.19

2nd Stage Value
1st Stage Value
Value of Stock

24.99
10.71
2.28
37.98
Overvalued

65.8% of total stock value

28.2% of total stock value
6.0% of total stock value

H-Model for the last 2 stages. Note: Assumes 1st Stage=2 years

total stock value

total stock value
total stock value

Chapter 3 - Discounted Dividend Valuation

Calculating the sustainable growth rate using the DuPont formula
Example for Slides 42-43

ASSUMPTIONS
Net Profit Margin
Total Asset Turnover
Equity Multiplier
Retention Ratio
OUTPUT
Return on Assets
Return on Equity
Sustainable growth rate

5.00%
1.5
2.0
60%

7.50%
15.00%
9.00%

formula