Valuation Methods | Definition | Examples

Running head: QUESTIONS 0
STOCK VALUATION MODELS
MARCH 30, 2020
STUDENT DETAILS

QUESTIONS 1
Part A: Comparison between Residual income, Dividend discount model and discounted cash
flow model
There are various methods of valuing the stock or organisation. One can follow the
relative valuation approach. Another alternative will be valuing the company based on the
absolute approximation, like applying discounted cash flow model or DDM, in making try to
make intrinsic value to said entity. One absolute valuation method that cannot be accustomed,
but is widely utilised by analyst, is residual income approach. Moreover, the residual income
model is method to equity valuation that properly accounts for cost of equity. The residual
income is considered as amount of net earning made in excess of minimum rate of return. In
calculating residual income, a main calculation is to decide the equity charges. It can see that
equity charges are usually total equity capital of company multiplied by equity’s required rate of
return, as well as may be estimated utilising CAPM The equity charge equation is discussed
below -
Equity Charge = Equity Capital x Cost of Equity
The dividend Discount Model is named as DDM. It Is a method where the price of stock is
measured on the basis of possible dividend, which would be paid and would be discounted at
expected per annum rate. The DDM or dividend discount method is the tool of measuring the
stock price of company on the basis of the theory that the stocks are worth the sum of payment of
probable dividend , discounted back to the PV. In different terms, it is utilised for valuing the
stocks on basis of NPV of the future dividend. The equation is discussed as follows -
Dividend Discount Model = Sum of PV of Dividend + PV of Stock Selling Price

QUESTIONS 2
The main strength of the DDM is that it is stranded in approach. The second benefit of the DDM
is that dividend tends to remain constant over long time. Company experience various volatilities
in measure such as earning as well as free cash flow. Though, the entity normally ensures that
dividend is only paid from money that is anticipated to be available with the organisation every
year. In addition, the dividend is the only amount of valuation available to minority shareholders.
In addition, the consistent compensation of dividend is a signal that the entity has matured in
businesses. It can say that the business is steady and there is no anticipation of confusion in the
upcoming period if something radical takes place. The data is valuable to different investors who
choose stability over option of quick gain.
Furthermore, the main disadvantage of dividend discount model covers trouble in making correct
projection. Another shortcoming is that it does not factor in buyback as well as fundamental
assumption of earning from dividend. In this way, DDM can be utilised to value the matured
organisation. Another deficiency of the DDM is s fact that the value’s calculation needs number
of assumptions regarding things like required rate of return as well as growth rate. It can
understand from a point that dividend yields changes considerably over the period. If the
projection or assumption created in calculation is even slightly in errors, this can result in the
forecaster determining a value for stocks that is meaningfully off in relation to being
undervalued or overvalued (Reis and Augusto, 2019).
Further, the discounted cash flow model is considered as financial model that is helpful in
valuing entity by forecasting the cash flow, as well as discounting cash flow to arrive at the
present value as well as current value (Hand, et. al, 2017). The discounted cash flow model has
difference of being extensively utilised in academe and in practices. The DCF analysis is
methodology of valuing task, companies, or assets utilising concepts of TVM. It can say that