Question #38
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 16
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
Kyle Star Partners is expected to have earnings in year five of $6.00 per share, a dividend payout ratio of 50%, and a required rate of return of 11%. For year 6 and beyond the dividend growth rate is expected to fall to 3% in perpetuity. Estimate the terminal value at the end of year five using the Gordon growth model.
Answer Choices:
A. $27.27
B. $37.50
C. $38.63
Explanation
The dividend for year 5 is expected to be $3 ($6 times 50%). The dividend for year 6 is then
expected to be $3.00 × 1.03 = $3.09. The terminal value using the Gordon growth model is
therefore:
terminal value = 3.09 / (0.11 − 0.03) = $38.625
P5 = D6 / (k − g)