Question

The three steps involved in the non-constant growth dividend discount model are:
      
A. Step 1: Set the investment horizon (year H) as the future year after which you expect the company's growth to settle down to a stable rate.
      
B. Step 2: Forecast the stock price at the horizon, and discount it also to give its present value today.
      
C. Step 1: Price estimated using the constant- growth formula to value the dividends that will be paid after the horizon date.
      
D. Step 3: Sum the total present value of dividends plus the present value of the ending stock price.
      
E. Step 2: Calculate the present value of dividends from the end of investment till horizon year.
      
F. Step 3: Estimate the rate of return of the stock to compare it with the price.

Choose the right three Steps in order.

Answer 1

In case of a non-constant growth dividend discount model, the growth rate of dividends vary for different period of time.

For example, in case of a 2 stage dividend discount model, the dividend growth rate for a certain time period is "g" and after that the growth rate (g1) remains constant forever( perpetuity)

So, the FIRST STEP is to Set the investment horizon (year H) as the future year after which you expect the company's growth to settle down to a stable rate.

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Next,We calculate the price of the stock when the growth rate is a constant (g1) and the dividends are paid in perpetuity using the formula : Price of stock (at t =H) = Dividend(at t =H) * [1 + g1]/(discount rate - g1)

So, the SECONG STEP is to Forecast the stock price at the horizon, and discount it also to give its present value today

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Next, we discount the dividends up to time t = H and also the dicount the value of the stock at t =H and add all the values to get the Present Value of Stock.

So, the THIRD STEP is to Sum the total present value of dividends plus the present value of the ending stock price.

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HENCE, the 3 steps involved are OPTION (A,B,D)