Question

For what type of firms is a Discounted Cash Flow (DCF) or Dividend Discount Model valuation technique most appropriate?

What would be the challenge of using a DCF or DDM approach to value a technology company?

Answer 1

Q: Dividend Discount Model and Type of Firm Most Suited For DDM Approach and challenge face by technology firm using DDM approach:

The company's stock price is the main aspect for it value, as it is the reflection of all activities associated like starting from production , manufacturing, selling goods and services and marketing etc. The company's profit increase or decrease is decided by its common stock price. It pays dividend to shareholders which is also effect of its stock price valuation.

The company's cash flows earned is the reflection of its stock price prevailing in the market. So the DDM model states that the value of a company is the sum of its present value of the future divedend payments. Which considers the growth rate of dividend, expected dividend per share, and cost of capital equity

Value of stock = Expected dividend per share / Cost of capital to equity - dividend growth rate

As the assumption in the DDM approach states that to value a company based on this approach That company must be a stable with good constant growth rate even if we can say that the company should be a well mature firm, constantly paying dividend to its shareholders is most suited firm for using DDM approach.

For example : Microsoft inc Alphabet inc are the mature stable firm and also the technology based firm use DDM approach , They follow intrinsic value of stock price , expected return , growth rate of their dividend payment. to value their company.