Chartered Financial Analyst Level 2

Explanation

The dividend discount model (DDM) is most appropriate in this scenario for several key reasons:

Key Factors Supporting DDM:

1. Recent IPO and Dividend Initiation: The company started paying dividends just six months ago, indicating it has transitioned to a dividend-paying company.

2. Constant Growth Expectation: The CEO expects constant growth in the future, which aligns perfectly with the Gordon Growth Model (a form of DDM) that assumes constant dividend growth.

3. Limited Debt History: While the company has a bond issued three years ago via private placement, this is insufficient for the bond yield plus risk premium approach, which typically requires a longer history of publicly traded debt.

Why Other Methods Are Less Appropriate:

• Fama-French Model: This is a multi-factor model that requires extensive historical data and market factors, which may not be available for a newly public company.

• Bond Yield Plus Risk Premium: This approach requires a reliable, observable bond yield. The company's bond was issued via private placement (not publicly traded), making its yield difficult to determine accurately. Additionally, the bond was issued three years ago, and market conditions may have changed significantly.

DDM Application:

The constant growth DDM formula is: [ r = \frac{D_1}{P_0} + g ] Where:

• ( r ) = required return on equity
• ( D_1 ) = expected dividend next period
• ( P_0 ) = current stock price
• ( g ) = constant growth rate

Given the company's recent dividend initiation and management's expectation of constant growth, DDM provides the most direct and appropriate method for estimating the required return on equity.