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Xcel CFA® Open Workbook Series

Master CFA Concepts Using MS Excel

Equity investment
Reading 54 Discounted Dividend Valuation Important tip for CFA Exam: CFA institute loves to test candidate on this topic, so you should expect a case study on the same.

Learn the following in this sheet: • Value of common stock using the DDM for one, two and multiple periods

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n Workbook Series ing MS Excel uation am: t candidate on this topic. so you should expect a case is sheet: k using the DDM for one. two and multiple periods om to download more spreadsheets from our Xcel in .

Statement 1: DDM takes the perspective of controlling shareholder. As per their policy.25 and $2. Undervalued B. H statements and asked him to keep them in mind while choosing DDM model. Q1. Presently $108 with expected earnings of $8 per year. $2. rest of the earnings get invested in growth opportunities with high expected returns. Both statements 1 and 2 Q2. Statement 2: DDM should be applied only if the firm’s dividend policy is consistent with the profitability trend. Bob asked him if any relation existed between justified leading P/E and justified trailing P proper thought. Starter Motor's leading P/E ratio attributable to PVGO is closest to: . Q4. 120.80 per share. he was correct with respect to: Options A. Based on multi-period DDM.45 at the end of next investor’s required rate of return is 8%. The current market price of shares is $134 while the investor expects it to be $149 Starter Motors is an automobile manufacturing firm with the required rate of return of 10%. Statement 1 B.19 C. company is expected to grow at 18% for the next three years. Presently. Martin. During the initial stages. Being a fresh hire from campus.10 B. The current market price of the shares is $8. For the past 10 years. Properly Valued C.Question John Orton recently joined a large pension fund as an equity analyst. he had to value stocks of following companies using appropriate model and come up with suitable recomme Rocking Roller is a ball bearing manufacturing firm which is expected to pay dividends of $2. Statement 2 C. Martin to get them resolved. 112. Out of the two statements made by Mr. he went through a 4 weeks the project work. this future dividend will continue to grow with the rate of return is 12%. Mr. they have bee their earnings. who w could begin. comment whether Rocking Roller is: Options Overvalued A. As per the industry experts. As a part of training. After having conversation with his supervisor.1. no div dividend with 30% payout ratio starting from year 4. Comparing fundamental value with current price. the current value of Rocking Roller shares is closest to: Options A. one of his friends.86 Q3. Company is currently in its initial growth phase and management plans to pull With the reported earnings of $1. John reached on to the correct solution. John faced some conceptual doubts and approached his supervisor. Kool Kola is a new player in the beverage market. 124. shares of this company are properly priced. As per the analyst. John decided to discuss this topic during lunch with his fellow members.

0% 74. Undervalued B. depicting relation between justified leading P/E and justified trailing P/E for a growth firm is: Options Justified leading P/E is more than Justified trailing P/E A.Options A. C. Properly Valued C. Based on two-period DDM. 35. Correct reply for Bob's query. Justified leading P/E is less than Justified trailing P/E B.9% Q5. Q6. comment whether Kool Kola is: Options Overvalued A. C. B.1% 25. Data Insufficient .

$2. Presently. who were also fresh recruits. After giving it a .45 at the end of next three consecutive years. no dividend is paid but it plans to roll out dend will continue to grow with the long-term rate of 4% and the required rvisor.25 and $2. Mr. Presently.from campus. r the next three years. His supervisor made two lunch with his fellow members. he went through a 4 weeks training before being assigned and come up with suitable recommendation. they have been paying dividends linked to ties with high expected returns. of $2. Before he eading P/E and justified trailing P/E for a growth firm. 10%. The e the investor expects it to be $149 at the end of three years.1. their shares are trading at company are properly priced. For the past 10 years. wth phase and management plans to pull in huge funds for expansion. Martin to get them resolved.

stified trailing P/E for a growth firm is: .

8 18% 3 30% 4% 8 . from year 4 Long-term growth rate Current Market Price ($) r E0 gS TS 1-b4 gL P0 12% 1.45 149 134 Starter Motors Required return on equity No growth earnings level ($) Current Price ($) r E P0 10% 8 108 Kool Kola Required return on equity Earnings per share ($) Short-term growth rate Duration of short-term growth (yrs) Dividend payout ratio.25 2.Rocking Roller Required return on equity Dividend expected to be received at end of Year 1 ($) Dividend expected to be received at end of Year 2 ($) Dividend expected to be received at end of Year 3 ($) Price expected upon sale at end of Year 3 ($) Current Price ($) r D1 D2 D3 P3 P0 8% 2.10 2.

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00 Leading P/E ratio attributable to PVGO Correct Option C Ans 5: Earnings in year 3. E1 will be greater than E0 by the factor of (1+g). .5/13. after the short-term growth period Earnings in year 4 Dividend in year 4 Terminal Value in year 3 Fundamental Value = = = = = E0*(1+gS) E3*(1+gL) E4*(1-b4) D4/(r-gL) V3/(1+r)TS TS Since fundamental value ($8.5 = 3.5 3.21) is greater than the current market pric Correct Option B Ans 6: For a growing firm.e. So.5 28. $108 V0 – E/r PVGO = = P/E firm P/E PVGO = = 13.10 Ans 3: Correct Option A Since fundamental value ($124.10) is less than the current price ($134) Ans 4: For properly priced shares.Ans 1: Correct Option B Statement 1 is wrong as DDM takes the perspective of an investor who and cannot control the dividend policy Ans 2: Fundamental Value Correct Option = A D1/(1+r) + D2/(1+r) + (D3 + P3)/(1+r) 1 2 3 = 124. fundamental value is equal to market price i.

So. E1 will be greater than E0 by the factor of (1+g).Correct Option B For a growing firm. . be smaller than the justified trailing P/E (P 0/E0).

96 3.21 8.92 11.53 8. shares are undervalued by the factor of (1+g). the justified leading P/E (P0/E1) will .10) is less than the current price ($134).9% = = = = = 2. shares are overvalued = 25. So.perspective of an investor who owns a minority stake in the firm $124.21) is greater than the current market price ($8).08 0.

So. . the justified leading P/E (P0/E1) will /E0).by the factor of (1+g).