COMMERCE 2FA3 Chapter 5: Finance - Chapter 5.docx
16 Mar 2014
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Dividend discount model (ddm: common stock represents true ownership, preferred shares, more bond like than stock like, have fixed dividends that must be declared/paid before common shareholders receive anything, required return expression: v0 = (d1 + p1)/(1 + ke, d1 = expected dividend, p1 = what you expect to sell the stock for at that time, must discount back to the present using ke, dividend discount model (ddm), v0 = d1/(1+ke) + d2/(1+ke)2 + d3/(1+ke)3 + , says that value of a share is what shareholders will receive over time in the form of cash payments but with future payments discounted back to present. Determination of discount rate ke = required return on equity for the stock in question: two approaches for choosing rate, use current short term (t bill) rate, replace risk free rate with a long term average of future expected short rates, ex.
