Practice Problem – Dividend Discount Model

Practice Question

Intro to Finance
Equity Valuation
Dividend Discount Model
Short Answer

Moderna Inc. just paid a dividend of $3.50 per common share. The growth rate in dividends is expected to be 20% per year for the first four years, and 2% per year thereafter. Investors require a 16% return per year in this stock for the first four years, and 12% per year thereafter. Calculate the current share price.

Answer +
Correct Answer:
$19.44
Explanation +

Step 1: Calculate Future Dividends

  • Current Dividend (D₀): $3.50
  • Year 1: D₁ = 3.50 × 1.20 = 4.20
  • Year 2: D₂ = 4.20 × 1.20 = 5.04
  • Year 3: D₃ = 5.04 × 1.20 = 6.048
  • Year 4: D₄ = 6.048 × 1.20 = 7.2576
  • Year 5: D₅ = 7.2576 × 1.02 ≈ 7.4057

Step 2: Calculate Present Value of Future Dividends

  • PV₁ = 4.20 / (1.16) = 3.62
  • PV₂ = 5.04 / (1.16²) = 3.74
  • PV₃ = 6.048 / (1.16³) = 3.87
  • PV₄ = 7.2576 / (1.16⁴) = 4.01
  • PV₅ = 7.4057 / (1.12⁵) = 4.20

Step 3: Total Present Value

PVₜₒₜₐₗ ≈ 3.62 + 3.74 + 3.87 + 4.01 + 4.20 = $19.44

Final Answer: The current share price of Moderna Inc. is approximately $19.44.