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PP Equity Valuation

Implications of the model implications 1 stock price

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Unformatted text preview: eriods of time. Implications of the model Implications 1. Stock price will increase: 1. If investors expect a large dividend K decreases g increases 2. Stock price is expected to grow at the same 2. rate as dividends rate When the stock is priced to equal its intrinsic value: E(R) = D1 / P0 + g E(R) = K Disadvantages of the DDM Disadvantages Model can’t be applied to firms who don’t Model pay dividends pay Model can’t be applied when g>K Can’t handle firms with variable dividend Can’t growth growth Example: A share of stock will pay a dividend of $3.0 one year from now, with dividend growth of 5% thereafter. The stock is correctly priced at $30 today in accordance with constant DDM. If the required return is 15%, what should the value of the stock be 2 years from now? value First we need to find the dividends in year 3: Dividend in year 3 = $3 x (1.05) 2 = $3.31 The price in year two is based on the expected dividend paid in year 3 and the dividend growth rate. P2 = D3/ ( k-g) = 3.31 / ( 0.15 – 0.05) = $33.10 What happens when dividend growth is What not constant? constant? Step 1: Step Find dividends over the variable growth period, using the variable growth rate. period, Step 2: Find the price of the stock in period t (after the variable growth period) using the normal/constant growth rate (g). the Step 3: Discount all cash flows back to the present to find V0. present Example: Assume divi...
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