Two-Stage Dividend Discount Model
In five years, a company growing at 12% annually will likely grow at a sustainable rate of 2%. If today's dividend was AUD 0.89 per share and an 8.5% discount rate is assumed, what is the present value of the terminal price?
No, actually.
It's possible to calculate this value by discounting just the Period 6 dividend to the present, omitting the standard denominator in the Gordon growth model.
Not exactly.
This is the present value of a terminal price calculated with the Year 5 dividend. But recall that the next-period dividend must be used, and so an extra compounding period is needed in the numerator.
You got it!
The value of the firm can be estimated with a two-stage dividend discount model as:
$$\displaystyle V_0 = \sum\limits_{t=1}^n \frac{D_0(1 + g_S)^t}{(1 + r)^t} + \frac{D_0(1+g_S)^n (1 + g_L)}{(1 + r)^n (r - g_L)} $$ .
The present value of the terminal price is just the second part of this large expression, which in this case is:
$$\displaystyle PV_{\mbox {termprice}} = \frac{0.89(1+0.12)^5 (1 + 0.02)}{(1 + 0.085)^5 (0.085 - 0.02)} = 16.37 $$.
AUD 1.06
AUD 16.05
AUD 16.37
