Explanation

Correct Answer: B (present value model)

Why this is correct:

1. Present value models (also known as discounted cash flow models) directly incorporate dividends into their valuation formulas. The most common present value models for equity valuation are:

   • Dividend Discount Model (DDM)
   • Gordon Growth Model (a specific form of DDM)

2. Dividend Discount Model (DDM) formula: $V_0 = \frac{D_1}{r - g}$ Where:

   • $V_0$ = intrinsic value of the stock
   • $D_1$ = expected dividend next period
   • $r$ = required rate of return
   • $g$ = constant growth rate of dividends

3. Direct relationship: In DDM, an increase in the dividend payout ratio directly increases $D_1$ (the expected dividend), which in turn increases the intrinsic value $V_0$, assuming all other factors remain constant.

Why other options are incorrect:

A. Multiplier model (incorrect):

• Multiplier models (like P/E, P/B, P/S ratios) use market multiples based on earnings, book value, or sales.
• An increase in dividend payout ratio typically reduces retained earnings, which could potentially reduce future earnings growth.
• This might actually decrease intrinsic value under multiplier models if earnings growth expectations decline.

C. Asset-based valuation model (incorrect):

• Asset-based models value companies based on their net asset value (assets minus liabilities).
• Dividend payout ratio affects the distribution of earnings but doesn't directly change the underlying asset values.
• Paying dividends reduces cash assets, which could potentially decrease asset-based valuations.

Key Concept: Present value models explicitly incorporate dividends into their valuation framework, making them sensitive to changes in dividend policy. The Dividend Discount Model directly links dividend payments to intrinsic value, so increasing the dividend payout ratio (and thus expected dividends) increases intrinsic value, assuming the required return and growth rate remain unchanged.