Discounted Dividend Valuation

Question 1

Justified leading P/E

Answer 1

(Po/E1) = (D1/E1) / (r-g) = (1-b) / (r-g)

Question 2

Justified trailing P/E

Answer 2

(Po/Eo) = [(Do(1+g)) / Eo] / (r-g) = [(1-b)(1+g)] / (r-g)

Question 3

Dividends are appropriate definitions of future cash flows in stock valuation models when

Answer 3

The company has a history of dividend payments;
The dividend policy is clear and related to the earnings of the firm;
The asset is being valued from the position of a minority shareholder

Question 4

Free cash flow is appropriate when

Answer 4

The company does not have a dividend payment history or has a dividend payment history that is not related to earnings;
The free cash flow corresponds with the firm’s profitability;
The asset is being valued from the position of a controlling shareholder

Question 5

Residual income is most appropriate for firms that

Answer 5

Do not have dividend payment histories;
Have negative free cash flow for the foreseeable future;
Have transparent financial reporting and high-quality earnings