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    Sarahwills Posts: 4, Reputation: 1
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    Nov 18, 2012, 08:26 PM
    How to calculate dividend discount model?
    The board of directors decided to pay dividends of $0.28 per share next year. After which its dividends are expected to grow at 5 percent per year into the foreseeable future. The beta is 2.1, market rate of return is 9 percent, and T-bills of 6 percent. If the shares are currently selling for $3.50, should the company's shares be purchased?

    Based on my own assumption,

    1. Step 1: I calculate the required rate of return.
    Ke= rf +Beta (rm-rf)= 0.06 +2.1(0.09-0.06)= 0.123= 12.3% (required rate of return)

    2. Step 2: If the share's is selling at $3.50, should the shares be purchased?
    Should I use:
    Current Share price of $3.50 + Dividend of $0. 28 (1+0.05)
    (1+0.123)
    = 3.38

    or should I use:
    Current Share price of $3.50 + Dividend of $0. 28
    (1+0.123)

    = 3.37

    Question b: If you have predicted that the current growth rate of 5 percent will reduced to 3 percent from year 4 and the later growth rate will continue into an indefinite future. What would be your decision now?

    Based on my own assumption I see that:
    D1= $0.28
    D2= $0.28 (1+0.05)=$0.294
    D3= $0.294 (1+0.05)= $0.3087
    D4= $0.3087 (1+0.03)= $0.3178

    0.28/ (1.123) + 0.294/ (1.123)^2 + 0.3087/(1.123)3 + [0.3087/ (0.123-0.03)] /(1.123)^3

    = $3.044 ( Is this correct? )


    Could anyone please help me, and tell me where I am wrong? I am confuse with the question sentences. Thank you!

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