Business Finance DDM model

Topics: Dividend yield, Dividend, Stock market Pages: 2 (762 words) Published: November 5, 2014

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Part One :
1) Artic Cooling 2) National Heating & Cooling 3) HVAC Corp $15.19$0.82 = 18.52
$12.49$1.32 = 9.46 $48.6$2.34 = 20.77
PE ratio = 18.52
PE ratio = 9.46
PE ratio = 20.77
Industry Simple Average PE Ratio:
18.52+9.46+20.773 = 16.25
Ragan’s Stock Price:
EPS of Ragan = $320,00050,000 X 2 = $3.2
Stock Price based on Industry Benchmark PE:
16.25 = Stock Price3.2 = 52
Thus , the stock price is $52 if the firm’s earning is 320,000.

Part Two
“Caution is warranted when using PE ration to value stocks”.There are two main reasons: PE Ratio cannot show the value of stock comprehesively
In some cases, there will be a fall or up of share prices because of some market fears about the economy even the company still has a stable situation.Sometimes, when there is economic crisis all over the world, there will be a fall in stocks price and value investor will buy the stocks in a large amount.Focusing on the PE ratio is a good way to make the decision on buying the stock. 2. PE ratio could be meaningless to the decision

It is very difficult to say whether a high or low PE ratio is good time for investment.The point is that we should find out that what is the cause of high PE ratio or low PE ratio. For example, a company has sold part of their brand to other firms and result in a strong earning.This increase EPS greatly.However, the decrease in market price will be followed as a weaker performanace will be forseened.Overall , the stock price will decrease and it results in a lower PE ratio.It may mislead some of investors to buy the stock . Apart from PE ratio, Dividend Discount Model (DDM) will be a better way to value the stock price. The DDM model seeks to value a stock by using predicted dividends and discounting them back to their present value. The Formula of DDM is Dividend per share over discount rate minus dividend growth rate. Value of Stock = D1

R- G
Where,
• DPS (1) = Dividends per share...
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