Present value models: DDM and FCFE

In short

• Present value models rest on a basic idea: people invest for future benefits, so value = PV of those benefits.
• Dividend discount model (DDM): $V_0 = \sum D_t/(1+r)^t$ over all future years.
• For an n-year holding period: PV of n dividends + PV of the expected sale price $P_n$ (the terminal value). The value does not depend on the holding period.
• FCFE = CFO − fixed capital investment + net borrowing. It measures dividend-paying capacity and works for non-dividend payers.
• The required return r often comes from the CAPM: $r = R_f + \beta \times$ equity risk premium. There is no single correct r.