How to Calculate Market Value of Shares Using Dividend Discount Model (DDM)
How can we calculate the market value of Lawrence Industries' shares?
Lawrence Industries' most recent annual dividend was $1.81 per share and the firm's required return is 14%. Dividends are expected to grow at 10% annually for 3 years, followed by a 5% constant annual growth rate. What is the market value of Lawrence's shares?
Calculating the Market Value of Lawrence Industries' Shares
The market value of Lawrence's shares can be calculated using the Dividend Discount Model (DDM). This model takes into account the present value of future dividends to determine the market value of shares.
First, we need to calculate the present value of the dividend stream during the first 3 years:
PV = D0(1+g)/(1+r) + D0(1+g)^2/(1+r)^2 + D0(1+g)^3/(1+r)^3
Where:
D0 is the most recent annual dividend ($1.81 per share)
g is the annual growth rate (10%)
r is the required return (14%)
Next, we calculate the present value of the dividend expected in year 4 and beyond:
PV = D4/(r - g)
Finally, we sum these two present values to get the market value of Lawrence's shares:
Market Value = PV(first 3 years) + PV(year 4 and beyond)
By plugging in the given values and following the calculations, we can determine the market value of Lawrence's shares.
Understanding the Dividend Discount Model (DDM)
The Dividend Discount Model (DDM) is a valuation method used to determine the intrinsic value of a company's stock based on the present value of expected future dividends. It assumes that the value of a stock is the sum of all its future dividend payments, discounted back to the present value.
By applying the DDM to Lawrence Industries, we are able to calculate the market value of their shares by considering the expected growth rate of dividends for the first 3 years and the subsequent constant growth rate. This calculation provides investors with an estimate of the value of the company's stock based on its anticipated dividend payments.
It's important to note that the DDM relies on certain assumptions and inputs, such as the expected growth rate of dividends and the required return, which can impact the calculated market value of shares. By understanding and utilizing the DDM, investors can make informed decisions about investing in a company's stock.