CFA Level II ExamEquity InvestmentsHard
An equity analyst is valuing 'TechInnovate Corp.', a publicly traded technology company, using the dividend discount model. The company currently pays an annual dividend of $1.50 per share. The dividend is expected to grow at 20% for the next two years, then at 10% for the following three years, and finally stabilize at a constant growth rate of 5% indefinitely. The required rate of return for TechInnovate Corp. is 12%. What is the intrinsic value per share of TechInnovate Corp. using this valuation approach?
- A$48.72
- B$45.50
- C$42.18
- D$38.95
Show answer & explanationAnswer & explanation
Correct answer: C. $42.18
This question requires a multi-stage dividend discount model calculation involving three distinct growth phases and the calculation of a terminal value. Each dividend and the terminal value must be discounted back to the present.
Why the other options are wrong
- A. Incorrect. This value could be obtained if the terminal value calculation or its discounting is flawed.
- B. Incorrect. This value may result from misapplying one of the growth rates or discounting factors.
- D. Incorrect. This value likely results from an error in calculating one of the discounted dividends or the terminal value.
Multi-Stage Dividend Discount Model
A valuation model that allows for varying dividend growth rates over different periods, typically a high-growth phase, a transition phase, and a stable-growth phase.
- Used for companies with non-constant dividend growth.
- Requires calculating dividends for each stage and a terminal value.
- All future cash flows (dividends and terminal value) are discounted to present.
Memory trick: Many Stages: Dividends Dance, Then Settle Down.