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NISM Certifications · NISM-Series-XV: Research Analyst · Valuation Principles

In a two-stage dividend discount model, which of the following is the correct treatment of the terminal value at the end of the high-growth stage?

Terminal value in a two-stage dividend discount model is the next year's dividend divided by the difference between required return and stable growth rate, and it is then discounted back to the present, because it represents value at the end of the high-growth stage.

  1. AIt is computed by capitalising the dividend of the first stable-growth year by (required return minus stable growth rate) and then discounted back to todayCorrect
  2. BIt is computed by multiplying the current dividend by the high growth rate and is not discounted
  3. CIt is computed by dividing the last high-growth dividend by the required return only, ignoring growth, and then added undiscounted
  4. DIt is the sum of all high-growth stage dividends

Explanation

Terminal value at the end of the explicit period equals D(n+1)/(ke - g), using the stable growth rate g. It is a future value, so it must be discounted to present value along with the explicit dividends. The other options ignore growth or discounting.

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