IV.%20DDM - IV DDM and FCFF Growth Model We examine some...

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1 IV. DDM and FCFF Growth Model We examine some growth valuation models; A. The DDM- dividend discount model B. FCFF growth model C. Super-to-normal FCFF growth model D. Finding DDM from FCFF model E. Spreadsheet versus model approach F. Application to terminal value estimation
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2 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 (= (eps-d)/eps) 1-b = payout ratio (= d/eps)
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3 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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4 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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