Module 29.3 LOS 29.i: Understanding when multistage DDM is applicable

There are different multistage models we often prefer to use to value a company, as the single stage model assumption of perpetual dividends can be seen as unrealistic. We chose the model that best matches with a firm’s expected pattern of growth.

The most basic multistage model is a two-stage DDM in which we assume the company grows at a high rate for a relatively short period of time (the first stage) and then reverts to a long-run perpetual growth rate (the second stage).

In the H-model, we assume that the growth rate starts out high and then declines linearly over the high-growth stage until it reaches the long-run average growth rate. 

Three-stage models are appropriate for firms that are expected to have three distinct stages of earnings growth. A three-stage model is a slightly more complex refinement of a two-stage model. 

Finally, in practical application, we can use a spreadsheet to model any patter of growth for any length of years, as long as we have the necessary data on a firm.

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