Question

Authors such as Fama and French use the dividend discount model in order to study the equity premium puzzle. While it surely has its drawbacks, the attractiveness of the dividend discount model stems from its solid consideration of Answer

Answer 1

The dividend discount model of valuation of the share has come up with shortcoming like

a)not usable for non-dividend paying company.

b)the valuation of the shares as not dependent on earnings of the company, but accumulated income reserve.

c)the assumptions of the growth rate in perpetuity is contradictory.

d)the required rate of return is variable factor which never be constant, so the model is not reliable.

The dividend discount model stems are solid when the result out of it is analyzed. The required rate of return over and above the perpetual dividend growth rate is defined as premium added to the share value out of the dividend.

The authors such as Fama and French uses the dividend discount model to add premium to the equity. This is because the dividend discount model is defined as basis of valuing the share present value through discounting the expected future dividends. The formula of dividend discount model is Present value of share = Up-coming Dividend / (Req. rate of return – growth rate).

Theoretically, the dividend discount model is well proven model which set the premium of up-coming dividend in the present value of the share. The share price is calculated at the declaration of each and every dividend.

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