Friday, November 8, 2013

How to use your calculator's NPV functions to complete a two-stage dividend discount model

I got my but kicked on the CFA Institute mock exam yesterday, mainly because I ran out of time. I've been going through the calculations and trying to find ways to speed them up a bit. Here's one that anyone with a TI BA 2 plus calculator, or just about any calculator with net present value (NPV) functions.

Valuing a company with a period of accelerated dividend increases to be followed by a a slower more stable rate requires you to find the DDM value at the point in time where the accelerated dividend growth stops, then add that to previous dividends

Borrowing from Mock Exam - morning session, question 82 (available free to registered candidates):
The accelerated dividend distributions are: D1=$2.00, D2=$2.50, and D3=$3.13
The first slow/stable distribution is: D4=$3.28
Here's the crux of using the two stage model: use the DDM to find a value for the company's shares at time 3 using the given investor required rate of return, $3.28/(0.12-0.05)=$46.86

Add that to the last accelerated distribution for the cash flow at time 3: $46.86+$3.13=$49.99 ~ $50.00

Now, here's how to use your calculator's NPV functions to find a current value per share:
CF0=0, CF1=2, CF2=2.5, CF3=50, I=12

This gives you a NPV=39.37, which is a penny off from the answer.

Sorry about the lack of subscripts, but I think you can get the picture from here. Go ahead and hit me up with any questions.