# Dividend Discount Model for a stock and its derivatives

This might be a bit basic but I've found this question and I'm definitely over-thinking it and now I've just completely confused myself. I'm just looking for some clarification.

I've been given the following information on a stock and its derivatives and I've been asked to determine the stock price using the Dividend Discount Model. To calculate this I know I could use the Gordon Growth Formula, I have the dividend per share and I believe the growth rate of the dividend is 0, since it stays at £1. What I need is the cost of equity, which I think I can obtain using the CAPM. My problem here is that I'm not sure how to obtain the risk free rate, Beta of the stock, and the market risk premium. I've tried a few calculations but none seem correct (I get VERY low values).

If anyone could show me how I would obtain the values I need from the information given I would really appreciate it. I understand this might be a bit basic for this site but I've managed to overthink my way into a deep hole.

As you've said, you can apply a version of the DDM, namely the gordon growth model -- assuming a constant growth of dividends.

GGM = D1 / (r-g)

So you need the cost of equity, the future dividends, and a growth rate.

In your case, the required return on equity is basically the cost of equity -- it's just another word for it. Required return on equity is the return investors require for the equity: required return on equity = risk-free rate + equity risk premiums

From the companies point of view this required return investors demand is a cost, i.e., the cost of equity.

The growth rate in your case can be calculated as: g = Retention Ratio * ROE (see sustainable growth rate).

Then you have:

PV= (D0*(1+g))/(r-g)

BTW: Since you have long-term and short-term ROE you can calculate a long-term and short-term growth rate. So to consider that, you can use the H-model, for example.

• Ah, ok, thanks a lot May 11, 2021 at 15:41
• Yeah my issue was I didn't know required return on equity was equal to cost of equity (Now i look back at it I don't know how i didn't piece that together). I also didn't know that growth rate formula, thanks for putting it in. May 11, 2021 at 18:43
• Just wondering, does anyone know how this method would differ if I wanted to use the FCFF instead of the DDM to find the stock price? May 27, 2021 at 11:44
• To discount the FCFF, you have to use the weigthed average cost of capital (WACC). May 29, 2021 at 10:05