Something I don’t understand… “RI model valuation is applicable to non-dividend paying firms” and we have the signle-stage RI model: V0 = B0 + [(ROE-r)xB0 / (r-g)] My problem is that if there is no dividend, then g = ROE and, using the above formula, I find: V0 = V0 = B0 + [(ROE-r)xB0 / (r-ROE)] = B0 - B0 = 0 That makes me think that “if there is no dividend, then the value is 0”, so the RI model valuation is NOT applicable to non-dividend paying firm… Have I missed something? Thank you for your help. Marc
dont think of the RI valuation thing in terms of dividents… basically, what the valuation tool means it that a companies value is its book value + any economic profit (res income) it makes… economic profit is basically a return in excess of a required return investors could bet elsewhere. so as long as ROE>r, there is an economic profit and thus RI… avoid thinking of dividends for this model. and yes i knwo finance isn’t perfect, but believe me, it beats engineering
Thank you aladak. My problem is that I don’t see the difference with the Gordon Growth model… For me it is two ways to look at the same thing. When applying dividends models or RI models we find the same answer. So why saying that one methods is “better” because it works even when there is no dividend if it gives exactly the same result? Oh, by the way, I’m also an engineer… Marc
DDM: value company using dividends RI: value company using economic profits both models mutally exclusive of each other. valuation is my strength of level 2. hopefully it will be tested a lot
DDM: V0 = E1 x (1-b) / (r-g) RI: V0 = B0 + [(ROE-r)xB0 / (r-g)] If you rearrange the DDM you obtain the RI (I can show you if you are not convinced). Both models are intrinsically the same thing… I can learn that they are different, mutually exclusive (and will use it for the exam). But in fact (I think) they are not…
Looking at your equation. V0 = V0 = B0 + [(ROE-r)xB0 / (r-ROE)] = B0 - B0 = 0 i think you made an error you cant cancel. (ROE-r)/(r-ROE)
V0 = B0 + [(ROE-r)xB0 / (r-ROE)] V0 = B0 + [(ROE-r)xB0 / (-1)(-r+ROE)] V0 = B0 + [(ROE-r)xB0 / (-1)(ROE-r)] V0 = B0 - 1*[(ROE-r)xB0 /(ROE-r)] V0 = B0 - 1*[B0] V0 = B0 - B0 V0 = 0
also, a major difference between the two is that RI valuation is based on a known present book value, which makes up the majority of the overall value. DDM, on the other hand, derives most of its value from an estimated terminal value, which is highly sensitive to changes in estimates (e.g., growth rate)
mhannebert Wrote: ------------------------------------------------------- > Something I don’t understand… > > “RI model valuation is applicable to non-dividend > paying firms” and we have the signle-stage RI > model: > V0 = B0 + [(ROE-r)xB0 / (r-g)] > > My problem is that if there is no dividend, then g > = ROE and, using the above formula, I find: > V0 = V0 = B0 + [(ROE-r)xB0 / (r-ROE)] = B0 - B0 = > 0 > That makes me think that “if there is no dividend, > then the value is 0”, so the RI model valuation is > NOT applicable to non-dividend paying firm… > > Have I missed something? Yep, Gordon Growth model formula assumes that r > g but in case ROE > r then this formula won’t be valid. So you cannot use, RI value model as shown above if ROE > r and ROE = g. If ROE < r and r = g then this formula gives the correct result. Since ROE < r, you are actually destroying value and if you keep on doing that the entire firm value should be destroyed.
kabhii Wrote: ------------------------------------------------------ > If ROE < r and r = g then this formula gives the > correct result. Well, if r=g, you will have an issue in both formulas…
Look at that: RI: V0 = B0 + [(ROE-r) x B0 / (r-g)] same as: V0 = B0 x (r-g) / (r-g) + [(ROE-r) x B0 / (r-g)] same as: V0 = [B0 x (r-g) + (ROE-r) x B0] / (r-g) same as: V0 = [B0 x r - B0 x g + ROE x B0 - r x B0] / (r-g) same as: V0 = [- B0 x g + ROE x B0] / (r-g) or ROE x B0 = E1 and g x B0 = ROE x b x B0 = b x E1 same as: V0 = [- b x E1 + E1] / (r-g) same as: V0 = E1 x (1-b) / (r-g) which is DDM Conclusion 1: RI model = DDM model Conclusion 2: I don’t understand why the RI is more versatile or can be used differently than the DDM…
mhannebert Wrote: ------------------------------------------------------- > kabhii Wrote: > -------------------------------------------------- > ---- > > If ROE < r and r = g then this formula gives > the > > correct result. > > > Well, if r=g, you will have an issue in both > formulas… Another typo mistake, thats happening for the second time today. I meant ROE = g.
if retention is 0, growth is 0. g = b*ROE, so if b=0, g =0 (and not ROE) So Vo = Bo. value of firm remains the same.
yodhava, We said if there is no *dividend* then g = ROE and then V0 = B0 You say if there is no *retention* then g = 0 and then V0 = 0 That is fine. There is no contradiction at this point.
dinesh.sundrani Wrote: ------------------------------------------------------- > V0 = B0 + [(ROE-r)xB0 / (r-ROE)] > V0 = B0 + [(ROE-r)xB0 / (-1)(-r+ROE)] > V0 = B0 + [(ROE-r)xB0 / (-1)(ROE-r)] > V0 = B0 - 1*[(ROE-r)xB0 /(ROE-r)] > V0 = B0 - 1* > V0 = B0 - B0 > V0 = 0 agree. if a company has no dividend payouts forever, then its value is zero
mhannebert Wrote: ------------------------------------------------------- > yodhava, > > We said if there is no *dividend* then g = ROE and > then V0 = B0 > You say if there is no *retention* then g = 0 and > then V0 = 0 > > That is fine. There is no contradiction at this > point. Sorry that is to be read: We said if there is no *dividend* then g = ROE and then V0 = 0 You say if there is no *retention* then g = 0 and then V0 = B0
I get your point. Well, the general residual income model I think doesn’t assume any dividends growth; you can have 0 dividends. But the simplified single stage model does assume constant dividend and earnings growth, so in this case, we cannot assume “no dividends” paid.
Dsylexic Wrote: ------------------------------------------------------- > dinesh.sundrani Wrote: > -------------------------------------------------- > ----- > > V0 = B0 + [(ROE-r)xB0 / (r-ROE)] > > V0 = B0 + [(ROE-r)xB0 / (-1)(-r+ROE)] > > V0 = B0 + [(ROE-r)xB0 / (-1)(ROE-r)] > > V0 = B0 - 1*[(ROE-r)xB0 /(ROE-r)] > > V0 = B0 - 1* > > V0 = B0 - B0 > > V0 = 0 > > > > agree. if a company has no dividend payouts > forever, then its value is zero I do not agree. If a company has no dividend payouts then the above formula cannot be applied assuming ROE >= g. If ROE < g, then above formula can be applied and the value of the firm in that case will be 0.