Ishika jainBeginner
In this question from Equity Valuation, it is given in question that the additional profit will be generated after one year but in answer we did not do the PV of Y1 and directly considered the amount of Cash I/F as PV Of Cash I/F. Why?
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Hey Ishika,
The process itself is done for deriving Present Value.
Simply put, why do you take D1 (Year 1’s dividend) for calculating Present Price?
Same logic is applied here. Future maintainable profit will be 15.3 (from year 1) after which it will consistently grow at 4% growth rate. So applying the same logic we have put gordon’s formula and derived Present value of inflow.
If it were to be in the question that 15.3 will give 6% growth rate for 4 years and then it will grow constantly at 4% then we would have taken two stage growth formula and derived the present value.
Point being, remember the formula’s logic and things will be clear.
I hope you know why we take D1 in the formula and not D0. Just in case, We take D1 because Price should reflect the future earning capacity of the stock which D1 gives and not D0 which is then discounted at desirable rate of dividend yield ie. Re – g.
I hope your doubt is clear. All the best! :))