Question

Why use the firms dividends to measure its value?

would FCF be a better measure of a firms value?

is a share of common stock a better investment than a share of preferred stock?

Answer 1

The dividend discount model calculates the true value of a form based upon the dividend paid by the company. The reason for using dividend as a measure for value in the form is direct dividend represents the true cash flows going to the shareholders.

The free cash flow method is a better method since our company may or may not pay dividends but may still be profitable. The biggest advantage of this model is that it can be used with different forms which do not pay regular dividend. Under this method to free cash flows of the business are discounted to their present values to arrive at the value of the company as a whole.

Whether a common share is better than a preference share depends upon the investor preferences. If an investor wants high risk and high return he should prefer a common stock since that has a high potential for getting high dividend as well as capital gains. If the investor wants low risk he should invest in a preference share because that comes with a fixed rate of return.