DDM valuation

Question 0

PV of growing annuity formula?

Answer 0

Write it down

Annuity= C•[ (1-(1+r)^-n)/r]

Growing annuity=
C•[{1-((1+r)/(1+g))^-n}/(r-g)]

Question 1

DDM attempts to value P directly as investors consider the value of their claim a PV o future dividend cash flows. What do you have to estimate or assume?

Answer 1

You have to estimate :
Life of the asset
Dividend of the asset and
Discount rate to apply

You have assume dividend growth stages:
No growth
Constant growth
Growth phases - ie staged growth

Question 2

How you calculate value of growths?

Answer 2

Value of stable growth=
Price with stable growing divs - price with no divs

Value of X’ordinary growth=
Price with X’ordinary growth divs - price with stable growth divs

Value of total growth=
Value of stable + X’ordinary growth

Question 3

Advantage of DDM

Answer 3

Theoretically sound

Predictable (works well when payout ratio is fixed)

Question 4

Disadvantages of DDM

Answer 4

• dividend payout is actually not related to value( at least in the short run)
• forecast horizon has to be much longer to be reliable
• payout ratio is management decision which mean arbitrary decision by management, some firms borrow to pay dividends

Focus should be creation of wealth rather than distribution of wealth