Business Finance DDM model Essay Sample

Part One:
1 ) Artic Cooling 2 ) National Heating & A ; Cooling 3 ) HVAC Corp $ 15. 19 $ 0. 82 = 18. 52
$ 12. 49 $ 1. 32 = 9. 46 $ 48. 6 $ 2. 34 = 20. 77
PE ratio = 18. 52
PE ratio = 9. 46
PE ratio = 20. 77
Industry Simple Average PE Ratio:
18. 52+9. 46+20. 773 = 16. 25
Ragan’s Stock Price:
EPS of Ragan = $ 320. 00050. 000 Ten 2 = $ 3. 2
Stock Price based on Industry Benchmark PE:
16. 25 = Stock Price3. 2 = 52
Therefore. the stock monetary value is $ 52 if the firm’s earning is 320. 000.

Part Two
“Caution is warranted when utilizing PE ration to value stocks” . There are two chief grounds: PE Ratio can non demo the value of stock comprehesively
In some instances. there will be a autumn or up of portion monetary values because of some market frights about the economic system even the company still has a stable state of affairs. Sometimes. when there is economic crisis all over the universe. there will be a autumn in stocks monetary value and value investor will purchase the stocks in a big sum. Concentrating on the PE ratio is a good manner to do the determination on purchasing the stock. 2. PE ratio could be meaningless to the determination

It is really hard to state whether a high or low PE ratio is good clip for investing. The point is that we should happen out that what is the cause of high PE ratio or low PE ratio. For illustration. a company has sold portion of their trade name to other houses and consequence in a strong earning. This addition EPS greatly. However. the lessening in market monetary value will be followed as a weaker performanace will be forseened. Overall. the stock monetary value will diminish and it consequences in a lower PE ratio. It may misdirect some of investors to purchase the stock. Apart from PE ratio. Dividend Discount Model ( DDM ) will be a better manner to value the stock monetary value. The DDM theoretical account seeks to value a stock by utilizing predicted dividends and dismissing them back to their present value. The Formula of DDM is Dividend per portion over price reduction rate subtractions dividend growing rate. Value of Stock = D1

R- G
• DPS ( 1 ) = Dividends per portion expected to be received in one twelvemonth
• R = The needed rate of return for the investing
• G = Growth rate in dividends = ROE x net incomes keeping ( or 1 subtractions dividend payout ratio ) By the information given. we can there cipher the stock monetary value. Premises:

1. The first large premise that the DDM makes is that dividends are fix and are non likely to alter in the hereafter. This means it has a changeless growing rate indefinitely. DDM requires forecast the future dividends. But even for steady. dependable. utility-type stocks. it can be slippery to calculate precisely what the dividend payment will be following twelvemonth. For illustration. company will pay fewer dividends if they want more equity to spread out. 2. Besides. the divident payment may turn as little but changeless rate. With tis 2nd attack. the equity of the company is considered to be sempiternity. 3. Apart from this. it assumes dividends are the lone manner investors receive money from the companies and any re-investment would be ignored. Restrictions:

1 ) Underestimate of the value of stock
The DDM has a rigorous trust on dividends agencies that the value of stock will be underestimated if the companies pay out less than they can afford and doing accretion in the equity. For illustration. Amazon earned big net income but they choose to reserve the equity instead than paying out so much dividends. 2 ) Unapplicable to companies which do non pay dividends.

Some companies may non pay dividends in order to keep the liquitity of the company or enduring the loss. Thus. 2 DDM theoretical account can non use to these companies. 3 ) Ignores Redemptions
A house may purchase back a big sum of stock in one twelvemonth and non purchase back stock for the following 3 old ages. For that ground. a much better estimation of the modified payout ratio is likely to be obtained by looking at the mean value. 4 ) Premise Dependent

There are tonss of premises to be made ( E. G. growing rates. clip frame. or the needed rate of return ) . and the theoretical accounts can be really sensitive to those premises. Even a really little error can ensue in overestimating or underestimating a stock in a really big extent. 5 ) Too conservative in gauging the stock value:

Dividend price reduction theoretical account does non reflect the value of unutilized assets or intangibles. for illustration. patents and reputes. In decision. dividend price reduction theoretical account is another manner of valuing the stock monetary value based on the information given. However. there are still some restrictions to DDM.

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