Reading 18
Discounted Dividend Valuation
3 modules 39 min
0/3
Exam Focus
This topic review presents the use of dividend discount models, one of the classes of models using the present value of future cash flows to determine the value of a stock. Dividend discount models use forecasted dividends as the estimate of cash flow to the shareholder. This material has several important topics that will require careful study.
You should be able to choose the appropriate model for the firm to be valued (based on the pattern of expected dividend growth), forecast the future dividends to be discounted, and determine the appropriate discount rate to apply. You should also understand the concept of sustainable growth and be able to estimate a firm’s sustainable growth rate.
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Modules
- Module 18.1DDM BasicsCompare dividends, free cash flow, and residual income as inputs to discounted cash flow models and identify investment situations for which each measure is suitable. · Calculate and interpret the value of a common stock using the dividend discount model (DDM) for single and multiple holding periods.9 min · 2 LOS
- Module 18.2Gordon Growth ModelCalculate the value of a common stock using the Gordon growth model and explain the model’s underlying assumptions. · Calculate the value of non callable fixed rate perpetual preferred stock. · Describe strengths and limitations of the Gordon growth model and justify its selection to value a company’s common shares. · Calculate and interpret the implied growth rate of dividends using the Gordon growth model and current stock price. · Calculate and interpret the present value of growth opportunities (PVGO) and the component of the leading price to earnings ratio (P/E) related to PVGO. · Calculate and interpret the justified leading and trailing P/Es using the Gordon growth model.8 min · 6 LOS
- Module 18.3Multiperiod ModelsExplain the growth phase, transition phase, and maturity phase of a business. · Explain the assumptions and justify the selection of the two stage DDM, the H model, the three stage DDM, or spreadsheet modeling to value a company’s common shares. · Describe terminal value and explain alternative approaches to determining the terminal value in a DDM. · Calculate and interpret the value of common shares using the two stage DDM, the H model, and the three stage DDM. · Explain the use of spreadsheet modeling to forecast dividends and to value common shares. · Estimate a required return based on any DDM, including the Gordon growth model and the H model. · Calculate and interpret the sustainable growth rate of a company and demonstrate the use of DuPont analysis to estimate a company’s sustainable growth rate. · Evaluate whether a stock is overvalued, fairly valued, or undervalued by the market based on a DDM estimate of value.22 min · 8 LOS