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Dividend Discount Model

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Assumptions1. The firm is expected to grow at a higher growth rate in the first period.

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2. The growth rate will drop at the end of the first period to the stable growth rate.

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3. The dividend payout ratio is consistent with the expected growth rate.

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Inputs needed1. Length of high growth period

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2. Expected growth rate in earnings during the high growth period.

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3. Dividend payout ratio during the high growth period.

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4. Expected growth rate in earnings during the stable growth period.

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5. Expected payout ratio during the stable growth period.

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6. Current Earnings per share

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7. Inputs for the Cost of Equity

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How the model worksThe expected dividends are estimated for the high growth period, using the payout

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ratio for the high growth period and the expected growth rate in earnings per share.

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The expected growth rate is estimated either using fundamentals:

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Expected growth = Retention Ratio * Return on Equity

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Alternatively, you can input the expected growth rate.

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At the end of the high growth phase, the expected terminal price is estimated using

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dividends per share one year after the high growth period, using the growth rate

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in stable growth, the payout ratio in stable growth and the cost of equity in stable

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growth.

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The dividends per share and the terminal price are discounted back to the present at

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the cost of equity changes.

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If your cost of equity in stable growth is different from your cost of equity in high

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growth, the cost of equity in the second half of the stable growth period will be

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adjusted gradually from the high growth cost of equity to a stable growth cost of

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equity.

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Options AvailableYou can make this model into a three stage model by answering yes to the question

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of whether you want me to adjust the inputs in the second half of the high growth

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period. If you do, I will adjust the growth rate, the payout ratio and the cost of

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equity from high-growth levels to stable growth levels gradually.

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You can also make this a stable growth model by setting the high

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growth period to zero.