Question

You have been asked to perform a stock valuation prior to the annual shareholders meeting next week. The two models you have selected to value the firm are the dividend discount model and the discounted cash flow model. Explain why the estimates from the two valuation methods differ. Address the assumptions implicit in the models themselves as well as those you made during the valuation process.

Answer 1

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Differences between these two approaches:

DDM:

Whereas DDM more specific in its approach to calculate value per share.

DDM is based on the dividends the company pays its shareholders.

It's the present value of all the future dividends.

It can only be used for companies which pay a dividend.

DCF:

Whereas DCF more specific in its approach to calculate value per share.

DCF is based on the cash flows of the company over its lifetime.

It's the present value of all the future cash flows.

It can be used for both type of companies

1. That pay a dividend.

2. That don't pay a dividend.

Assumptions:

The WACC or Re, Growth rate.

Wacc= weighted average cost of capital.

Re= required rate of return.