Model
BY:
DHEERAJ MAHAJAN (19 -MBA-16)
KOMAL GUPTA (30 -MBA-16)
PRIYANKA SHASHU(44 -MBA-16)
SUMEET KOUR (62-MBA-16)
Theory of Valuation
Present Value of
Price/Earning Ratio (P/E)
Dividends (DDM)
Where:
Vj = Value of Stock j
n = life of an asset
CFt = cash flow in period t
k = the discount rate that is equal to the investors required
rate of return for Asset j, determined by the uncertainty (risk)
of the assets cash flows
The Dividend Discount Model
(DDM)
Where:
Vj = Value of Stock j
Dt = dividend during Period t
K = required rate of return on Stock j
If stocks are sold after 2 Years
V0 = D1/ r-g
The process of estimating the inputs to
be used in infinite period DDM:
ESTIMATING THE REQUIRED RATE OF RETURN:
1. ESTIMATING THE REAL RISK FREE RATE
2. ESTIMATING THE EXPECTED RATE OF
INFLATION
3.CALCULATING THE NOMINAL RISK FREE
RATE:
(1+ REAL RISK-FREE RATE)*(1+ EXPECTED RATE
OF INFLATION)-1.
4.ESTIMATING THE RISK PREMIUM OF THE
STOCK.
5.CALCULATE THE REQUIRED RATE OF RETURN
ESTIMATING THE DIVIDEND
GROWTH RATE
ESTIMATE THE FIRMS RETENTION RATIO
ESTIMATE THE FIRMS EXPECTED RETURN ON EQUITY
CALULATE THE DIVIDEND GROWTH RATE:
RETENTION RATE (b) * return on equity (ROE)
THE INFINITE PERIOD DDM HAS
4 ASSUMPTIONS:
The stock pays dividend
Dividend grow at a constant rate (g)
The constant growth rate will continue
forever.
The required rate of return is greater than
the growth rate; otherwise the model
breaks down since the denominator is
negative.
GROWTH COMPANIES
These are the companies that have the
opportunities and abilities to earn rate of return
on investments that are consistently above their
required rate of return.