How do I calculate intrinsic value using the two-stage DDM?

The two-stage DDM is used when a company is expected to grow dividends at a higher rate initially and then settle into a lower sustainable rate. It combines a high-growth phase with a terminal value at the transition point.

Formula:

V_0 = Sum of PV(dividends during high-growth phase) + PV(terminal value)

Where the terminal value at year N uses the Gordon Growth Model:

TV_N = D_(N+1) / (r - g_stable)

Full Worked Example:

Brightwater Industries pays a current dividend (D_0) of $2.00. You expect:

• High growth rate: 15% for 3 years
• Stable growth rate: 4% thereafter
• Required return (r): 11%

Step 1: Project dividends during high growth

Year	Dividend	Calculation
D_1	$2.30	$2.00 x 1.15
D_2	$2.645	$2.30 x 1.15
D_3	$3.042	$2.645 x 1.15

Step 2: Calculate terminal value at end of Year 3

D_4 = $3.042 x 1.04 =$3.163

TV_3 = $3.163 / (0.11 - 0.04) =$3.163 / 0.07 = $45.19

Step 3: Discount everything back to today

Cash Flow	Year	PV Factor (11%)	PV
D_1 = $2.30	1	0.9009	$2.072
D_2 = $2.645	2	0.8116	$2.147
D_3 = $3.042	3	0.7312	$2.224
TV_3 = $45.19	3	0.7312	$33.04

V_0 = $2.072 +$2.147 + $2.224 +$33.04 = $39.48

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Common Mistakes:

1. Using D_0 instead of D_1 in the terminal value. The Gordon model needs the next period's dividend, so at Year 3, you need D_4.
2. Forgetting to discount the terminal value. TV_3 is the value at Year 3, not today. You must discount it back 3 years.
3. Adding D_3 twice. D_3 is a regular dividend AND the base for the terminal value. Count the dividend payment in Year 3 AND the terminal value — but D_3 is not inside the terminal value (D_4 is).

When to use 2-stage vs. Gordon:

• Gordon (single stage): mature companies with stable, sustainable growth
• Two-stage: companies in growth phases (tech, biotech) expected to normalize

Check out our CFA equity valuation course for video walkthroughs of multi-stage DDM problems.