14.6 Valuation using dividend discount model

Question 1

What is the dividend discount model (DDM)?

Answer 1

Dividend valuation model based on the principle that current share value is a discounted reflection of the cumulative value of all future dividends.

Question 2

What assumptions are made when calculating dividend discount model (DDM)?

Answer 2

• shareholder income with be paid as dividends
• dividends will be aid in perpetuity
• dividends will be constant or will grow

Question 3

How is the value of stock calculated using the dividend discount model (DDM)?

Answer 3

Current stock value = Σ (present value of all future cash flows)

Question 4

What are the three models used in Gordon’s dividend discount model (DDM)?

Answer 4

1 Zero growth rate - assumes dividends do not grow year on year (they remain constant)
2 Constant growth rate - assumes dividends grow by a fixed percentage each year
3 Variable growth model - assumes growth rate is variable