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vinsu, Professor
Category: Finance
Satisfied Customers: 522
Experience:  MBA in Finance and Marketing
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Fiancial Managment and theoretical price

Customer Question

why does the calculations from the constant growth model and the current stock price differ?
Submitted: 11 years ago.
Category: Finance
Expert:  vinsu replied 11 years ago.

They differ because of

The first big assumption that the DDM makes is that dividends are steady, or grow at a constant rate indefinitely. This is assumption does not hold in reality

The dividend discount model generally understates the intrinsic value of the firm. Important considerations such as the value of patents, brand name, and other intangible assets should be used in conjunction with the DDM to assess the value of a firm's equity. These intangibles should be added to the result of a DDM calculation to arrive at a more appropriate valuation.

The dividend discount model does not account for the volatility in stock prices. The prices change everyday, but the model results will not change.

The Dividend Discount Model works best for firms with stable growth rates, firms which pay out dividends that are high and approximate FCFE and firms with stable leverage.

Customer: replied 11 years ago.
Reply to Vineet Swarup's Post: Why is it that when I make calculations using the constant growth model, I don't get the same figures as I find on their stock quote site. I've tried to calculate the price-to-earning ratio and the theoretical price using this model but it's not adding up to the information provided on their stock page. Is their some reason for this? I don't understand the acronyms that you list in your reply. I'm not all that stock literate so can you please explain it a little more simplier? Please...I apologize if I'm being a little picky. :)
Expert:  vinsu replied 11 years ago.

First the acronyms - DDM is Dividend Discount Model,FCFE is Free Cash Flow to Equity

The reasons that you do get the same price from DDM is as I have explained earler due to - volatility is stock prices, they chnage everyday but DDM values do not. DDM works best if the payout ratio is high and DDM undertstaes the price since it does not take into account the brand name an dother intrinsic factors.

When you use P/E, it is forward looking, the P/E captures the expecte dgrowth in the future but DDM is backward looking, you see the dividends paid and not what the diivdends could be due to growth of the firm.

I hope this helps

vinsu and other Finance Specialists are ready to help you
Customer: replied 11 years ago.
Thanks for you help Professor. I posted the payment to you. :) Can I ask one more question? I calculated CAPM and got an answer. Then I increased the risk premium figure and used it in the same calculation using the previous Beta and growth rate as in the first equation. The answer that I got decreased when I increased the premium? I thought the number would increase since I increased the market rate. Does this seem right to you?