DDM and Gordon's growth Flashcards
how is g calculated for DDM and Gordon Growth?
retention ratio (1-payout) * ROE
which firm’s equity can be evaluated using Gordon’s growth model?
their g is well below the growth rate of the economy and they have a stable payout policy. (highly mature firms). it is usually used for firms that grow in tandem with the economy which have stable g over the long term.
what are limitations about GGM?
extremely sensitive to assumptions about g
what is an important alternative use of GGM?
can be used to calculate Ke without passing for the CAPM: ke=((payout ratio*(1+g))/ firm’s P/E ratio))+g
how does g change from the HG to the SG period of the DDM?
usually more mature firms have a higher payout ratio. this (keeping ROE constant) will decrease g but increase future dividends. at the same time a mature firm’s ROE must be consistent with industry expectations. thus, ROE might also decrease further decreasing g.
how does Ke change from the HG to the SG period of the DDM?
Ke might change from one period to the other as the firm adjusts its D/E ratio. a more mature firm might be able to afford increased leverage–> increasing ke.
limitations of the two stage DDM
It is challenging to estimate the length of the first growth stage in practice- Theshift from the first growth stage to stable growth is sudden, while in reality it is gradual- Focus on dividends can lead to skewed estimates of value for firms that are not paying out what they can afford (i.e.,
who accumulate cash)
two stage DDM works best for firms that…
have a limited period competitive advantage, stable g, committed to maintain stable payouts and do not accumulate cash.
in which cases should one consider more than 2 periods of DDM?
unripe firm’s whose payout and g cannot be captured easily within 2 periods and that have a limited time competitive advantage which is expected to gradually decrease overtime.
what is augmented payout ratio?
payout ratio that includes both dividends and stock repurchases
what is augmented payout ratio when repurchases are financed through debt?
(dividends + repurchases - debt issuance)/NI
CULOPISELLOhow to break down total EV in terms of individual growth components in the 2 period DDM?
EQ.V= value of assets in place + value of high growth + value of stable growth
what is value of assets in place?
DIV(t=0)/Ke(stable growth)
what is stable growth value?
DIV(t=1)/(Ke(stable growth)-g)-value of assets in place
what is high growth value?
total value-(DIV(t=1)/(Ke(stable growth)-g))
the second part of the subtraction represents the value of stable growth and the value of assets in place making the equation HG value = TOT value - SG value - value AIP.
