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Question 2 Describe two limitations of the two-stage DDM that are addressed by using the two-stage...

Question 2

  1. Describe two limitations of the two-stage DDM that are addressed by using the two-stage free cash flow for the firm (FCFF) model.
  1. Describe two limitations of the two-stage DDM model that are NOT addressed by using the two-stage FCFF model.
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Answer #1

A) Limitation One :- If no dividends are paid or earnings are negative DDM can not be used, But Cash Flow model can be used.

Limitation two:- DDM model cannot be used for No growth companies as dividens will be zero, but FCFF model can be used.

B) Limitation One :-Both DDM and FCFF faces the same challenge " what should be the first stage" i.e. the finite period or stage 1.

Limitation two :- Both DDM and FCFF faces the issue of growth rate assumptions i.e. higher growth rate in stage one and lower growth rate in stage 2 which is in perpetuity.

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