a. Illustrate the primary difference between the dividend discount models and th

Question

a. Illustrate the primary difference between the dividend discount models and the free cash flow to equity models.

b. Which model provides a better estimation of valuing firms for takeovers.

c. Will the following firms be likely to have a higher value from the dividend discount model, a higher value from the FCFE model, or the same?

1.firm that pays out less in dividends than it has available in FCFE, but invests the balance in treasury bonds.

2. a firm that pays out, on average, its FCFE as dividends

3. firm that pays out more in dividends than it has available in FCFE, and then issues stock to cover the difference.

Explanation / Answer

A.

Difference between the dividend discount models and the free cash flow to equity model IS MENTION BELOW:

1. Dividend discount model discount future expected dividend to determine current stock price while Free cash flow method use expected free cash flow to determine stock price.

2. Dividend discount model use cost of equity to discount future dividend while free cash flow method uses WACC to discount free cash flow.

3.  Dividend discount model does not use debt value of company while Free cash flow method does.

4.  Dividend discount model does not consider, future capital expenditure, depreciation in calculation of stock price while free cash flow does.

5. dividend discount model can be used for mature companies only that pays regular dividend while free cash flow can be used for all type of firm.

b.

Free cash flow method provides bettwe estimation of valuing firms for takeovers. this is because Free cash flow method consider debt value, capital expenditure and non-cash expenses that is depreciation.

c.

1.

firm that pays out less in dividends than it has available in FCFE, but invests the balance in treasury bonds have higher value from the dividend discount model

2.

a firm that pays out, on average, its FCFE as dividends have same value from the dividend discount model.

3.

firm that pays out more in dividends than it has available in FCFE, and then issues stock to cover the difference have lower. value from the dividend discount model

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