Explain rationale for using present value of cash flow models to value equity and describe dividen discount and free cahs flow to equity models?DDM?One Year hodling period DDM?Multi year DDM?FCFE model?
In the discounted cash flow models a stocks value is estimated and present of cash distributed to shareholders (dividend discount models) or the present value of cash avaialbe to shareholders after firm meets its necessary capital expenditure and working capital expenses ( FCFE model)
- DDM is based on intrinsic value of stock is present value of future dividend.
- -current stock value is Future dividend/reuired return on common equity.
- -One year is Future dividend/rrequired rate of return+Future Price/Required rate of return=Expected value
Multi Year - A stock recntyly paid out dividend of 1.00$ and expected to grow at 5% per year. Required rate of return is 13.2%. Calculate value of stock assuming priced at 14.12 in 2 years.
- D1 = 1*1.05=1.05
- D2= 1.05*1.05=1.103
14.12/(1.132)^2= 11.02+1.79= 12.81 is the current value based on investor expectation.
- FCFE = Net income +Depreciation-Increase in working capital-Investment in fixed capital-Debt Principal Repayments+new debt issue.
- Also, FCFE = CFO-FCInv+net Borrowing.
Net borrowing is amount borrowed mius amt repaid.