Question

In: Finance

You have been asked to perform a stock valuation prior to the annual shareholders meeting next...

You have been asked to perform a stock valuation 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.

Solutions

Expert Solution

Dividend discounting model is only focused around valuation of the stock using the dividend payments in order to estimate the overall future generation of the company so dividend paying company can only be valued using dividend discounting model.

Discounted cash flow model is related to discounting of the cash flow associated with the business and it will be trying to discount overall futuristic cash flow of the business in order to arrive at the value of the company.

The estimation related to both the method will be different because dividend discount model is always related to payment of dividend and because various companies are not paying dividend and they are instead investing into business discounted cash flow is a better method and it is trying to discount the overall cash flow which are generated by the company so all the company can be almost value using discounted cash flow method.

dividend discount model is only revolving around the principle of valuing stock on the basis of the payment of dividend so it is a very narrow approach and it also believes that dividends are sometime constantly increasing or their increasing differently in different period whereas discounted cash flow method will be valuing the cash flows by ascertainment of the time value of the money and it will also try to manage through cash flows which are estimated by application of growth criteria.


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