Dividend Discount
Model
FCFE Model
Dealing
with cash
and
marketable
securities
The income from cash
and marketable
securities is built into
earningsand ultimately
into dividends.
Therefore, cash and
marketablesecuritiesdo
not need to be added in.
You have two choices:
- Build income from
cash and marketable
securities into
projections of income,
and estimate thevalue
of equity.
2.Ignore incomefrom
cash and marketable
securities,andaddtheir
valuetoequityvaluein
model.
Ingeneral,whenfirmspayoutmuchlessindividendsthan
they have available in FCFE, the expected earnings and
terminalvaluewillbehigherinthedividenddiscountmodel,
buttheyear-to-yearcash flowswillbehigherintheFCFE
model.
What Does It Mean When They Are Different?
WhenthevalueusingtheFCFEmodelisdifferentfromthe
value using the dividend discount model, with consistent
growthassumptions,therearetwoquestionsthatneedtobe
addressed:Whatdoesthedifferencebetweenthetwomodels
tellus?Whichofthetwomodelsistheappropriateonetouse
in evaluating the market price?
ThemorecommonoccurrenceisforthevaluefromtheFCFE
modeltoexceedthevaluefromthedividenddiscountmodel.
ThedifferencebetweenthevaluefromtheFCFEmodeland