Initial Question:
You have been asked to perform and present a stock valuation to the CEO 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.
Reply to this part:
To complete a stock valuation many pieces of information are
required to include; the type of stock, stock prices for the last period,
current prices, the earnings per share, annual sales, etc. A stock valuation is
the process of calculating the fair market value of a stock by using a fixed
formula that considers various economic indicators. Stock valuation can be
calculated using several different methods but for this DQ we will be using the
dividend discount model and the discounted cash flow model. The dividend
discount model is a technique of valuing a company’s stock price based on the model
that its stock is worth the sum of all its future dividend payments, discounted
back to their present value. The discounted cash flow model is a method of
valuation in which future cash flows are discounted back to a present value
using the time-value of money. The results from the divided discount model are
not as reliable as they assume that the growth rate is stable, continuous and
less than the amount of capital required to produce the product. The discounted
cash flow model uses future cash flow projections and discounts them using an
annual rate to find a present value estimation. The present value is then used
to evaluate the stock in this case. If the present value is estimated at more than
the investment, then the stock is a good one. In the divided discount model, the type of
stock can change the equation, and for this example we will assume this is a
common stock. The stocks projected value after a year using the divided discount
model would be determined by an equation including the cost per share, the rate
of return in a percentage, and the price per share. If this stock had a closing
share price of $30 at year end, a common equity per share of $.25, and a rate
of return at 10% the projected value per share would be $27.50. This would be a
good return on investment and a fairly reliable model to use in the valuation
of the stock for the upcoming meeting.
Reference:
Brigham, E. F., & Ehrhardt, M. C. (2017). Financial management: Theory and practice (15th ed.). Mason, OH: South-Western
APA, At least one reference. 100-200 words.
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