CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
An analyst values a mature utility using the dividend discount model. Which cash flow does the model most likely discount to estimate the intrinsic value of a common share?
The dividend discount model discounts expected future dividends. A share is valued as the present value of the cash distributions an investor expects to receive, discounted at the required return on equity. Earnings and firm-level free cash flow belong to other models.
- AExpected future dividendsCorrect
- BExpected future net income
- CExpected future free cash flow to the firm
Explanation
The DDM treats a share as a claim on the dividends the investor expects to receive. Net income and free cash flow to the firm are inputs to other valuation approaches, not the cash flow discounted in the DDM.
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