Dividend Discount Model Example

Question

Ezzell Pakistan is a Public Limited Company listed on the three stocks exchanges of the country i.e. Karachi, Lahore and Islamabad. The company deals in manufacturing of Electric appliances. The research and development department of the corporation has developed a solar panel capable of generating 200 % more electricity than any solar panel currently available in the market. As a result of this achievement, the financial analysts in stock market expect that the company will experience a 15% annual growth rate for the next five years. By the end of 5 years, other firms will have developed comparable technologies; and the corporation’s growth rate will slow down to 5% per annum for an indefinite period. Stockholders require a return of 12% on Ezzell Pakistan‘s common stocks. The most recent annual dividend (Do), which was paid yesterday, was Rs.1.75 per share.


Required:
a) Calculate expected dividends of the company for the next five years.
b) Calculate the value of the stock today i.e. Po.
c) Calculate the expected dividend yields for 1st, 5th and 6th years.
(e.g., for 1st year Dividend yield = D1/ Po)


Marks: 2.5 + 3 + 4.5 = 10

Solution



Given data is
Growth rate = g1 = 15% (for next five years)
Growth rate = g2 = 5% (after five years for an indefinite period)
Required rate of return = 12%
D0 = Rs1.75 per share.


a) Expected dividends for the next five years.

As
D0 = Rs1.75 per share.

Dividend for the first year = D1 = D0 (1+g1) = 1.75 (1+ 0.15) = 1.75(1.15)
= Rs.2.0125

Dividend for the second year = D2 = D0 (1+g1)2 = 1.75 (1+ 0.15) 2 = 1.75(1.15) 2
= Rs.2.3144

Dividend for the third year = D3 = D0 (1+g1)3 = 1.75 (1+ 0.15) 3 = 1.75(1.15) 3
= Rs.2.6615

Dividend for the fourth year = D4 = D0 (1+g1)4 = 1.75 (1+ 0.15) 4 = 1.75(1.15) 4
= Rs.2.3.0608

Dividend for the fifth year = D5 = D0 (1+g1)5 = 1.75 (1+ 0.15) 5 = 1.75(1.15) 5
= Rs.3.5199




b) Value of the stock today i.e. P0

As per the conditions of the question there are two growth rates i.e. 15% for the next five years and 5% after five years for an indefinite period. To calculate P0, we will first calculate P5 i.e. value of the stock at the end of fifth year using constant growth model, because after the fifth year the growth rate remains constant.
So
P5 = = = = = Rs. 52.7986

Now to calculate P0 we discount back D1, D2 , D3 , D4 , D5 and P5 to the present date.
So
P0 = + + + + +


P0 = + + + + +



P0 = + + + + +


P0 = 1.7969+ 1.8450 + 1.8944 + 1.9452 + 1.9973 + 29.9601


P0 = Rs. 39.4388 (Value of the stock as of today)

c) Expected Dividend yields for 1st, 5th and 6th years.

Dividend yield for 1st year
= = = 5.1028 %

Dividend yield for 5th year
= = = 7%

Dividend yield for 6th year
To calculate dividend yield in the 6th year we required P6 and D7.

P6 = = = = = Rs. 55.4385

Dividend yield = = = 0.07 = 7%