Essay about Business Finance DDM model

759 Words4 Pages

Part One :
1) Artic Cooling 2) National Heating & Cooling 3) HVAC Corp
$15.19$0.82 = 18.52
$12.49$1.32 = 9.46 $48.6$2.34 = 20.77
PE ratio = 18.52
PE ratio = 9.46
PE ratio = 20.77
Industry Simple Average PE Ratio:
18.52+9.46+20.773 = 16.25
Ragan’s Stock Price:
EPS of Ragan = $320,00050,000 X 2 = $3.2
Stock Price based on Industry Benchmark PE:
16.25 = Stock Price3.2 = 52
Thus , the stock price is $52 if the firm’s earning is 320,000.

Part Two “Caution is warranted when using PE ration to value stocks”.There are two main reasons:
PE Ratio cannot show the value of stock comprehesively
In some cases, there will be a fall or up of share prices because of some market fears
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1. The first big assumption that the DDM makes is that dividends are fix and are not likely to change in the future .This means it has a constant growth rate indefinitely. DDM requires forecast the future dividends.But even for steady, reliable, utility-type stocks, it can be tricky to forecast exactly what the dividend payment will be next year.For example , company will pay fewer dividends if they want more equity to expand.
2.Also, the divident payment may grow as small but constant rate.With tis second approach,the equity of the company is considered to be perpetuity.
3. Apart from this, it assumes dividends are the only way investors receive money from the companies and any re-investment would be ignored.
1)Underestimation of the value of stock
The DDM has a strict reliance on dividends means that the value of stock will be underestimated if the companies pay out less than they can afford and causing accumulation in the equity. For example, Amazon earned large profit but they choose to reserve the equity rather than paying out so much dividends.
2)Unapplicable to companies which do not pay dividends.
Some companies may not pay dividends in order to maintain the liquitity of the company or suffering the loss. Thus,2 DDM model cannot apply to these companies.
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