In: Accounting
You have been asked to perform and present a stock valuation to the CEO prior to the annual shareholders meeting next week. The two models you have selected to value the firm are the dividend discount model and the discounted cash flow model. Explain why the estimates from the two valuation methods differ. Address the assumptions implicit in the models themselves as well as those you made during the valuation process.
1) Dividend discount model:
The dividend discount model is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value
Its formula is : P = D1/ (r-g)
where D1 is expected dividend for next year, r is Cost of equity and g is growth rate.
2) Discounted Cash flow method
CF analyses use future free cash flow projections and discounts them, using a required annual rate, to arrive at present value estimates.
Its formula is : DCF = [CF1 / (1+r)1] + [CF2 / (1+r)2] + ... + [CFn / (1+r)n]
where, CF = Cash flow, r= discount rate (WACC).
1) Assumptions is Dividend discount method:
2) Assumptions in Discounted Cash Flow model