The Dividend Discount Model (DDM)

The Dividend - The Dividend Discount Model(DDM • The value of a share of common stock is the present1 valueD2 all future dividends of D3 D D∞

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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 11-1 (1 + k ) ∞ The Dividend Discount Model (DDM) • The N-Period 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 11-stock 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 11-3 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 11-4 – • 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.

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The Dividend - The Dividend Discount Model(DDM • The value of a share of common stock is the present1 valueD2 all future dividends of D3 D D∞

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