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Unformatted text preview: The Dividend Discount Model
(DDM)
• The value of a share of common stock is
the present1 valueD2 all future dividends
of
D3
D
D∞
Vj = (1 + k ) + (1 + k ) 2 + (1 + k ) 3 + ... + Dt
=∑
(1 + k ) t
t =1
n where:
Vj = value of common stock j
Dt = dividend during time period t
k = required rate of return on stock j
111 (1 + k ) ∞ The Dividend Discount Model
(DDM)
• The NPeriod Model
– – If the stock is held for only N period, e.g. 2
years, and a sale at the end of year 2 would
SPj 2
D1
D2
+
+
imply:V j =
2
(1 + k ) (1 + k )
(1 + k ) 2 The expected selling price, SPj2, of 2
11stock j at The Dividend Discount Model
(DDM)
Infinite Period Model (Constant Growth
• Model)
– Assumes a constant growth rate for
D0 (1 +all)of future dividends D0 (1 + g ) n
g
D0 (1 + g ) 2
estimating
Vj =
+
+ ... +
2
(1 + k )
(1 + k )
(1 + k ) n where:
Vj = value of stock j
D0 = dividend payment in the current period
g = the constant growth rate of dividends
k = required rate of return on stock j 113 The Dividend Discount Model
(DDM)
Given the constant growth rate, the
• earlier formula can be reduced to:
D1
Vj =
k−g
• Assumptions of DDM:
– – Dividends grow at a constant rate
The constant growth rate will continue for
an infinite period
114 – • Infinite Period DDM
and Growth Companies to
Growth companies have opportunities
earn return on investments greater than
their required rates of return • • To exploit these opportunities, these
firms generally retain a high percentage
of earnings for reinvestment, and their
earnings grow faster than those of a
typical firm
During the high growth periods5where
11 ...
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This note was uploaded on 01/24/2012 for the course FIN 4360 taught by Professor Davidbray during the Spring '12 term at Kennesaw.
 Spring '12
 DAVIDBRAY

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