Applying the dividend discount model to determine cost of equity
Understanding the Dividend Discount Model (DDM): A Tool to Determine the Cost of Equity In the world of corporate finance and investing, understanding how to value a company's stock is crucial. One widely used and foundational method is the **Dividend Discount Model (DDM)**. This model helps estimate the **intrinsic value** of a stock based on the future dividends it will pay, discounted back to present value. It’s especially helpful for evaluating companies that have a steady dividend history, such as utilities or consumer goods firms. At its core, the DDM assumes that the true value of a stock is equal to the present value of all its expected future dividend payments. Investors who seek regular income through dividends often use this model to make informed investment decisions. Key Components of the DDM The basic formula of the **Gordon Growth Model** (a common form of DDM) is: $$ P_0 = \frac{D_1}{Ke - g} $$ Where: * **P₀** = Price of the stock today * **D₁** = Expected dividend...