Instead of the wrote formula approach, this analyst shows that such problems can be decomposed into their cash flows at different points in time, which enables us to use
IRR methods on a financial calculator to find the valuation as predicted by multi-stage DDM.
Although his answer was correct, I found it more intuitive to solve this way:
CF5 = 1 CF6 = 1.25 CF7 = 1.25^2 = 1.5625 CF8 = (1.25^3) + ((1.25^3 x 1.05)/0.103-0.05) = 40.64712
With those cashflows and
IRR of 10.3% we still get the right answer of $20.65 after hitting the calculator's
CPT button to find
So I thought, voila, this is awesome. But I encountered a different problem where I appear to be way off the mark using this approach.
An analyst feels that Brown Company’s earnings and dividends will grow at 25% for two years, after which growth fill fall to a constant rate of 6%. If the projected discount rate is 10% and Browns most recently paid dividend was $1 the value of Brown’s stock using the multistage dividend discount model would be:
A) 31.25 B) 33.54 C) 36.65
I interpreted this situation as follows:
CF0 = 1 CF1 = 1.25 CF2 = 1.25^2 = 1.5625 CF3 = 1.5625*1.06 + (1.5625*1.06)/(.1-.06) = 42.9688
IRR at 10, the calculator gave me an
NPV of 35.71. This matches none of the available choices. I fear I have blundered something.
What should be the proper sequencing of cashflow inputs if to solve "Brown Company" multi-stage DDM valuation on a financial calculator?