Question

In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm? Why?  

Answer 1

In cases in which the firms pay an annual dividend, we would use a dividend discount model. In case firms do not pay a dividend, we will use a free cash flow model to value the firm.

Hence to value the firm paying dividends, we use dividend discount model to value the firm. According to the dividend discount model, the current price (P0) is calculated as P0= D1/(r-g) where D1 is the dividend paid next year = D0*(1+g), "g" is the growth rate and "r" is the required rate of return.