# CFA Level 2 - Equity Session 11 - Reading 42 Discounted Dividend Valuation - LOS c

Topics: Economics

## CFA Level 2 – Equity, Session 11-Reading 42

### Discounted Dividend Valuation – LOS c

(Practice Questions, Sample Questions)

1. #### The value per share for Burton, Inc. is \$32.00 using the Gordon Growth model. The company paid a dividend of \$2.00 last year. The estimates used to calculate the value have changed. If the new required rate of return is 12.00% and expected growth rate in dividends is 6%, the value per share will increase by:

A) 4.17%.

B) 9.51%.

C) 42%.

[Explanation: (C) The value per share using the new estimates is \$35.33 = [\$2.0(1.06) / 0.12 – 0.06)] and the percentage increase in the value per share will be 10.

42% = [(35.33 – 32.00) / 32.00] × 100%]

1. #### Suppose the equity required rate of return is 10%, the dividend just paid is \$1.00 and dividends are expected to grow at an annual rate of 6% forever. What is the expected price at the end of year 2?

A) \$28.09.

B) \$27.07.

C) \$29.78

[Explanation: (C) The terminal value is \$29.78, and that is the price an investor should be willing to pay at the end of year 2. The correct answer is shown below.

Year

Dividend

1

\$1.0600

2

\$1.1236

3

\$1.1910

V3:\$1.191/(0.10 – 0.06) = \$29.78]

1. #### A company reports January 1, 2002, retained earnings of \$8,000,000, December 31, 2002, retained earnings of \$10,000,000, and 2002 net income of \$5,000,000. The company has 1,000,000 shares outstanding and dividends are expected to grow at a rate of 5% per year. What is the expected dividend at the end of 2003?

A) \$3.00.

B) \$3.15.

C) \$13.65.

[Explanation: (B) The first step is to determine 2002 dividends paid as (\$8,000,000 + \$5,000,000 ? 10,000,000) = \$3,000,000. The next step is to find the dividend per share (\$3,000,000 / 1,000,000 shares) = \$3.00 per share. Applying the 5% growth rate, next year’s expected dividend is \$3.15, or \$3.00 × 1.05.]

1. #### Jax, Inc., pays a current dividend of dividend of \$0.. Get quality help now Prof. Finch Verified Proficient in: Economics 4.7 (346) “ This writer never make an mistake for me always deliver long before due date. Am telling you man this writer is absolutely the best. ” +84 relevant experts are online 52 and is projected to grow at 12%. If the required rate of return is 11%, what is the current value based on the Gordon growth model?

A) unable to determine value using Gordon model.

B) \$58.24.

C) \$39.47.

[Explanation: (A) The Gordon growth model cannot be used if the growth rate exceeds the required rate of return.]

1. #### A firm currently pays a dividend of \$1.77, which is expected to grow at a rate of 4%. If the required return is 10%, what is the current value of the shares using the Gordon growth model?

A) \$29.76.

B) \$29.50.

C) \$30.68.

[Explanation: (C) The current value of the shares is \$30.68:

V0 = [\$1.77(1 + 0.04)] / (0.10 – 0.04)] = \$30.68.]

1. #### Jand, Inc., currently pays a dividend of \$1.22, which is expected to grow at 5%. If the current value of Jand’s shares based on the Gordon model is \$32.03, what is the required rate of return?

A) 8%.

B) 9%.

C) 7%.

[Explanation: (B) The required return is 9%: r = [\$1.22(1 + 0.05) / \$32.03] + 0.05 = 0.09 or 9%]

1. #### A firm’s dividend per share in the most recent year is \$4 and is expected to grow at 6% per year forever. If its shareholders require a return of 14%, the value of the firm’s stock (per share) using the single-stage dividend discount model (DDM) is:

A) \$53.00.

B) \$50.00.

C) \$28.57.

[Explanation: (A) The value of the firm’s stock is: \$4 × [1.06 / (0.14 ? 0.06)] = \$53.00]