Question

Between net realizable value and dividend discount model, is one method better than the other? why and why not?

Answer 1

Generally, the both methods of valuation 'net realizable value' and 'dividend discount method' are used in different contexts. There are specific advantages to each of the method. Based on the current market conditions related to the company, appropriate method needs to be used

1. Net Realizable Value: This method is used while arriving at the liquidation value of the company. It is generally used when the valuers feel that the company can no longer continue as a going concern. Since the company is expected to be liquidated, all the assets of the company needs to be re-valued at the net realizable value [NRV]. NRV measures the true value that the assets of the company going to be sold given the fact that the company is going to be liquidated. Generally NRV is net of the costs that are expected to occur during liquidation. NRV of all the assets minus the amount paid to all the creditors is the final liquidation value of the company.

Net Realizable value does not take into account any future growth of the company and hence will generally be less than any other valuation method such as dividend discount model or DCF which takes into account the future growth prospects for the industry/company

2. Dividend Discount Model [DDM]: DDM is generally used for a company which is running as a going concern and which has a history of paying dividends and expectation of paying dividends in the future. DDM is a method of valuing a company based on the concept that the value of a company is worth the sum of all the dividends that it will pay in the future on a continuous basis. In DDM, we generally inculcate the future growth prospects of the company through a growth in dividends.

While Net Realizable value will us a near accurate value, it is very difficult to arrive at the accurate value in DDM. DDM requires many assumptions on the going concerns and growth, which sometimes are not very accurate and hence the final result can't be predicted accurately.