# 2 stage DDM

When using the two-stage dividend discount model (DDM), an extremely low value might result when the: A) beta in the stable growth period is too low. B) growth rate in the stable growth period is too high. C) stable period payout ratio is too high. D) stable period payout ratio is too low.

I’ve done this one recently. I think it is A but I didn’t understand the reasoning. Anyone want to explain how they figured out an answer?

d?

C. Assuming ROE is positive.

I remember a debate about this like a month ago. I think the answer is D because the TV dividend is low creating a low value. I think I originally thought it was C. Am I right?

well who is going for B?

D? A - Required return is low, so value is high B - Growth is high, so value is high C - Numerator is high due to high payout. D - Numerator is low due to low payout.

I wastd 10 mins on this … and was so sure that the ans to this was C But look at this … disappointing When using the two-stage dividend discount model (DDM), an extremely low value might result when the: A) beta in the stable growth period is too low. B) growth rate in the stable growth period is too high. C) stable period payout ratio is too high. D) stable period payout ratio is too low. Your answer: C was incorrect. The correct answer was D) stable period payout ratio is too low. If an analyst gets an extremely low value using two-stage DDM, it is most likely that the stable period payout ratio is too low or the beta in the stable growth period is too high.

I am sticking to my original answer but I thought about it some more. A high beta would increase the required rate of return on equity thereby widening the difference between that and the growth rate. With the denominater being large, the value of the second stage would get small. Am I anywhere close?

Oops misread it as high beta. My eyes are getting tired…

if beta is high then required return is high then r-g is high denominator is high makes sense

mwvt9 Wrote: ------------------------------------------------------- > C. > > Assuming ROE is positive. Tell me where I am going wrong. D/(r-g) The larger the spread in the denominator the greater the discount, meaning the output of the equation would be a low value. g=ROE * Renention rate Since a low retention rate will lead to a small value of g and (1-rr)= payout ratio, wouldn’t a high payout ratio lead to a big spread in the denom and a low value for the model?

ups Dwight we are on same page

I thought exactly the same, but am speechless (sorry wordless…) now

dinesh.sundrani Wrote: ------------------------------------------------------- > I thought exactly the same, but am speechless > (sorry wordless…) now I think it is wrong. Someone convince me my logic is wrong above please.

the beta high makes sense, using CAPM you’re going to get a bigger # for r so your denominator gets bigger, causes a lower value. payout- if you paid out low, you retain more, your g is then bigger if you assume ROE would stay the same… if that were the case then you’d think r-g would be a smaller # and you’d wind up with an answer more like C. is the reason because in the stable growth phase you probably aren’t going to have great positive type NPV projects to invest those retained \$\$'s in so your ROE is going to be low if you keep all of the money inside vs paying it out? so by not paying it out you’d actually do more harm than good by crushing your ROE?

This seems rather simple to me. I guess that shows that I’m not getting it. Haha.

How so pink?

mwvt9 I think it a matter of perspective you are right in your logic the only thing is that the dividend payout influence can be felt right away and for the growth rate to change there is probably a lag

kabhii Wrote: ------------------------------------------------------- > D? > > A - Required return is low, so value is high > B - Growth is high, so value is high > C - Numerator is high due to high payout. > D - Numerator is low due to low payout. This must be what is messing me up. I was keeping the D constant in my analysis, but both the numerator and denominator change with a change in dividend payments. It appears that the numerator effect outweights the denominator.