Dividend Discount Model
Assumptions
1. The firm is expected to grow at a higher growth rate in the first period.
2. The growth rate will drop at the end of the first period to the stable growth rate.
3. The dividend payout ratio is consistent with the expected growth rate.
Inputs needed
1. Length of high growth period
2. Expected growth rate in earnings during the high growth period.
3. Dividend payout ratio during the high growth period.
4. Expected growth rate in earnings during the stable growth period.
5. Expected payout ratio during the stable growth period.
6. Current Earnings per share
7. Inputs for the Cost of Equity
How the model works
The expected dividends are estimated for the high growth period, using the payout
ratio for the high growth period and the expected growth rate in earnings per share.
The expected growth rate is estimated either using fundamentals:
Expected growth = Retention Ratio * Return on Equity
Alternatively, you can input the expected growth rate.
At the end of the high growth phase, the expected terminal price is estimated using
dividends per share one year after the high growth period, using the growth rate
in stable growth, the payout ratio in stable growth and the cost of equity in stable
growth.
The dividends per share and the terminal price are discounted back to the present at
the cost of equity changes.
If your cost of equity in stable growth is different from your cost of equity in high
growth, the cost of equity in the second half of the stable growth period will be
adjusted gradually from the high growth cost of equity to a stable growth cost of
equity.
Options Available
You can make this model into a three stage model by answering yes to the question
of whether you want me to adjust the inputs in the second half of the high growth
period. If you do, I will adjust the growth rate, the payout ratio and the cost of
equity from highgrowth levels to stable growth levels gradually.
You can also make this a stable growth model by setting the high
growth period to zero.
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Inputs from current financials
Net Income
=
$4,096.00
(in currency)
Interest income from cash and marketable securities =
$132.00
Last year
Book Value of Equity =
$12,072.00
$10,237.00 (in currency)
Cash and Marketable Securities
$2,475.00
$1,918.00
Market Value of Equity =
$357,352.00
Number of shares outstanding =
6222.40
Current Capital Expenditures =
$11,986.00
Current Depreciation =
$9,767.00
Change in noncash Working capital in most recent year =
$214.00
Net Debt Issued (Paid) during the year =
($1,951.00)
Do you want to normalize the net income/earnings per share?
Yes
Do you want to normalize your reinvestment needs?
Yes
If yes, these will be your normalized values
Normalized Net Capital Expenditures =
$4,242.61
Normalized Working Capital Change =
$336.31
Normalized Net Debt issued =
$1,864.62
Inputs for Discount Rate
Beta of the stock =
0.8
Riskfree rate=
4.50%
(in percent)
Risk Premium=
4.00%
(in percent)
Inputs for High Growth Period
Length of high growth period
5
Do you want to calculate the growth rate from fundamentals?
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 Fall '11
 BANKO
 Net Present Value, Financial Ratio, Dividend yield, Na Na Hey Hey Kiss Him Goodbye

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