ESSENTIALS OF INVESTMENTS - CONNECT ACCE
ESSENTIALS OF INVESTMENTS - CONNECT ACCE
11th Edition
ISBN: 9781266077951
Author: Bodie
Publisher: INTER MCG
Question
Book Icon
Chapter 13, Problem 1PS
Summary Introduction

To think critically about:

In what circumstances, one would prefer to choose a dividend discount model instead of a free cash flow model to value a firm.

Introduction:

The dividend discount model(DDM)- It is a method where the stock prices of the companies are valued based on the methodology that the stock has a worth to provide the future dividends and is discounted back to their present values.

Free cash flow(FCF) is a measure that states the amount of cash that a business generates after accounting for all the expenditures are capital in nature for example: Equipments, buildings etc.

Expert Solution & Answer
Check Mark

Answer to Problem 1PS

The answer is one would choose to use a dividend discount model to value a mature firm that pays a relatively stable dividend.

Explanation of Solution

In case of Free Cash Flow model, the firm is valued based on the cash flow available to it or its equity holders net of capital expenditures. Hence this approach is very useful for the firms that pay no dividends. However, for the firms that pay no dividends, Dividend discount model is difficult to implement as the basic assumption is the value of stock depends on dividend forecasts. Dividend discount model asserts that stock prices are determined ultimately by the cash flows accruing to stakeholders and those are in dividends.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Chapter 13 Solutions

ESSENTIALS OF INVESTMENTS - CONNECT ACCE

Knowledge Booster
Background pattern image
Recommended textbooks for you
Text book image
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Text book image
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:9781260013962
Author:BREALEY
Publisher:RENT MCG
Text book image
Financial Management: Theory & Practice
Finance
ISBN:9781337909730
Author:Brigham
Publisher:Cengage
Text book image
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Text book image
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Text book image
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education