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  • 5 years ago

Is it appropriate to use the dividend capitalisation model instead of CAPM to estimate the required rate of return in a DDM valuation?

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  1. anonymous
    • 5 years ago
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    No. Empirically,CAPM is still doing a better job than any other model.Making the model more sophisticated doesn't improve th eestimation

  2. anonymous
    • 5 years ago
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    Are you asking whether the discount rate derived using CAPM can be applied directly to a forecast of dividends as opposed to a forecast of free cash flow? If so, then the answer is yes, but you are assuming that dividends will closely approximate free cash flow which may not be a good assumption. Discounting dividends instead of free cash flow is a simplifying shortcut. If the company is not going to distribute all free cash flow (either due to stock buybacks or cash accumulation) then your forecast of dividends will undervalue the company. I suppose it would be possible to make an adjustment to the discount rate that would compensate for any projected difference between free cash flows and dividends, but this would be a very roundabout way of fixing the problem. To do this you would need to make an explicit assumption about earnings and the dividend payout ratio going forward. But then, if you are able to make this assumption, you might as well just discount the free cash flows anyway since that is a much more direct and accurate way of fixing the problem.

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