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No-Growth Dividend Discount Model (DDM)
Dividend Discount Model is the one of the earliest method adopted to calculate the value for the share. In this method the current present value of the share is calculated by using the predicted futuristic dividend that the company is expected to pay in the future. The general formula used to calculate net current value for the share is
Where P is the current share value, R is the expected rate of return and G is the growth rate of the company. The above formula is used when there is a growth in the organization.
The disadvantages in no growth dividend discount model are,
- The long term forecasting is highly difficult in this model. This becomes more difficult as we have to anticipate the dividend in the future. The company might change its dividend policy there by complicating things.
- The second major disadvantage in dividend no growth dividend discount model is that it does not take into consideration of the cash flow. It must be noted that the dividend paid by any company to its investor depends to a whole extend on the net cash flow.
- The potential change to the dividend that might take place when the company is taken over or merged into a new company is not taken into consideration in this model.
- The potential change to the dividend that might take place when the company takes over or merges a new company into it is not taken into consideration in this model.
A dividend discount model would typically be a discounted cash flow using dividend forecasts over several stages.
- If there are any dividends that have been announced but for which the share has not yet gone ex-dividend, these are known amounts in the near future and do not require forecasts.
- There are likely to be forecasts based on detailed financial models for the near future.
- Beyond that, forecasts based on less detailed models can be used
- Assuming a fixed growth rate beyond some point allows a terminal value to be calculated at that point
Despite the above disadvantages the no growth dividend discount model helps the investor in making decision about the purchase of the company security. The main advantage in this process is that it is easy to calculate.
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