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IV. DDM and FCFF Growth Model
We examine some growth valuation models;
A.
The DDM dividend discount model
B.
FCFF growth model
C.
Supertonormal FCFF growth model
D.
Finding DDM from FCFF model
E.
Spreadsheet versus model approach
F.
Application to terminal value estimation
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A. DDM model
We use the following notation to model stock price
P
t
=
stock price at the end of period t
d
t
=
dividend at the end of period t
eps
t
=
eps at the end of period t
r
S
=
the required return on equity
g =
the growth rate
b =
retention ratio (= (epsd)/eps)
1b =
payout ratio (= d/eps)
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Stock Price
In general, the stock pays dividends in perpetuity
DDM dividends grow at a constant rate, g, forever.
...
)
r
1
(
d
...
)
r
1
(
d
)
r
1
(
d
P
t
S
t
2
S
2
1
S
1
0
+
+
+
+
+
+
+
=
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The base DDM
From the constant perpetual dividends grow, (hence,
earnings per share = eps growth), we have the DDM
1
1
S
S
1
1
t
t 1
S
d
eps (1
b)
P
,
r
g
r
g
since, d
eps (
r
g
1
b), and d
d
(1
g)
we require


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