Dividend Discount Model

# Dividend Discount Model - Valuation: Dividend Discount...

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Valuation: Dividend Discount Model

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Dividend Discount Model (DDM) Equates the value of company equity with the present value of all future dividends Dividends are viewed similar to coupon payments on debt Discount rate is the cost of equity capital 2
Recursive Process of Valuation Value of equity at the end of period 3 IV0 = Dividends to be received during period 1 D1 + IV1 1 + re = + Intrinsic value of equity at the beginning of period one 1 + Cost of equity The stock price today depends on the expected price of the stock tomorrow, which in turn depends on the expected price of the stock the day after. Value of equity at the end of period

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Recursive Process of Valuation Example Eastern Company has an expected dividend for period 1 of \$1.50, and its expected intrinsic value of equity at the end of period 1 is \$32. The cost of equity capital for similar firms is 7.6%. What is today’s intrinsic value? 4 IV0 = D1 + IV1 1 + re IV0 = \$1.50 + \$32 1.076 = \$31.13
Dividend Discount Model Framework Equates current stock price to the present value of all future expected dividends 5 § Two methods to forecast future dividends through infinity § Perpetuity method § Constant growth method IV0 = D1 1 + re D2 (1 + re)2 + D3 (1 + re)3 + D4 (1 + re)4 + + …

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Dividend Discount Model with Constant Perpetuity Assumes that forecasted dividends stabilize at some point in the future and remain constant thereafter Yields an ordinary annuity with payments occurring at the end of a period through infinity 6 IV0 = D1 re
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## This note was uploaded on 11/21/2011 for the course BMGT 313F taught by Professor Seybert during the Fall '11 term at Maryland.

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Dividend Discount Model - Valuation: Dividend Discount...

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