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Dividend Discount
Model (DDM Model)
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Introduction
Financial theory states that the value of a stock is the worth all of
the future cash flows expected to be generated by the firm
discounted by an appropriate risk-adjusted rate. We can use
dividends as a measure of the cash flows returned to the
shareholder.
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Example
Some examples of regular dividend paying companies are
McDonalds, Procter & Gamble, Kimberly Clark, PepsiCo, 3M,
CocaCola, Johnson & Johnson, AT&T, Walmart etc. We can use
Dividend Discount Model to value these companies.
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TYPES OF DIVIDEND DISCOUNT MODELS
If a preferred share of stock pays dividends of $1.80 per year, and the
required rate of return for the stock is 8%, then what is its intrinsic value?
Solution:
Here we use the dividend discount model formula for zero growth dividend,
The shortcoming of the model above is that you’d expect most companies
to grow over time.
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CONSTANT-GROWTH RATE DDM MODEL
D1 = $4 x 1.06 = $4.24
Ke = 12%
Growth rate or g = 6%
Check Mate forecasts that its dividend will grow at 20% per
year for the next four years before settling down at a
constant 8% forever. Dividend (current year,2016) =
$12; Expected rate of return = 15%. What is the value of the
stock now?
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Step 4: Find the present value of Terminal
Value.