<p>Typically you use FCF if the company doesn't pay dividends. You can still use dividends starting in year 5 and if you discount the CFs back to year 0, it doesn't matter that you have 0 CF in the first four years, you'll still get the future value of all CFs at year 0. </p>

CC BY-SA 4.0
2018-06-12T14:32:54.290Z
2018-06-12T14:32:54.290Z
user18561
<p>With what you say and using the <a href="https://en.wikipedia.org/wiki/Dividend_discount_model" rel="nofollow noreferrer">DDM</a> we know that</p>

<p>$P_{t=4} = \frac{D_{t=5}(1+g)}{r-g}$</p>

<p>Via the above equation, it is <b>assumed</b> that from year $5$, dividends will annually grow at a $g$ rate and that investors' required rate will be $r$, both forever. Since this calculation is nothing but a <b>simplification</b> (future growth and return rates will <i>a fortiori</i> change, etc...), we will not do more complicated.</p>

<p>Taking into account the share of debt in the capital structure of the company, say $X\%$, we can compute the average cost of capital (average over equity and debt), $r'$, needed to discount $P_{t=4}$. One may <b>have an idea</b> of $X$ or <b>make assumptions</b> about it. It follows that $r'$ is such that</p>

<p>$r' = X\% r_D + (1-X\%) r$</p>

<p>where $r_D$ is the interest rate or the cost of debt (naturally <a href="https://en.wikipedia.org/wiki/Cost_of_capital" rel="nofollow noreferrer">$r_S &lt; r$</a>). Thus the company's IPO may be valued by involving that </p>

<p>$P_{t=0} = \frac{P_{t=4}}{(1+r')^4}$</p>

<p>Finally, as you can see there are <b>many assumptions</b> in this valuation, which is the job of experts, with the most fundamental about $D_{t=5}$.</p>

CC BY-SA 4.0
2019-10-17T11:40:52.180Z
Any question @Daniel64 ?
keepAlive
CC BY-SA 3.0
2016-12-05T20:41:46.817Z
2016-12-05T20:41:46.817Z
keepAlive
<p>Say a company is doing an IPO and we expect them to start paying dividends in 5 years?<br>
I understand how we could use the Dividend Discount Model to predict their stock price 4 years from the IPO. But what about the day of the IPO?  </p>

<p>How can we use the Dividend Discount Model to value this stock before it pays dividends?  </p>

CC BY-SA 3.0
2016-12-04T19:02:46.373Z
By adding up the net present values of the dividends? I am somewhat unsure what your exact question is.
Giskard
<finance><stock-market><financial-economics><financial-markets>
Using the Dividend Discount Model when no current dividend exists?
Daniel64
# Using the Dividend Discount Model when no current dividend exists?

(Asked by: username_0 on 2016-12-04)

Say a company is doing an IPO and we expect them to start paying dividends in 5 years?  
I understand how we could use the Dividend Discount Model to predict their stock price 4 years from the IPO. But what about the day of the IPO?

How can we use the Dividend Discount Model to value this stock before it pays dividends?

**Tags:** finance, stock-market, financial-economics, financial-markets

> **Comments:**
> **username_1**: By adding up the net present values of the dividends? I am somewhat unsure what your exact question is.  

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## 2 answers

### Answer by username_2 on 2018-06-12. Score: 1

Typically you use FCF if the company doesn't pay dividends. You can still use dividends starting in year 5 and if you discount the CFs back to year 0, it doesn't matter that you have 0 CF in the first four years, you'll still get the future value of all CFs at year 0.


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### Answer by username_3 on 2016-12-05. Score: 1

With what you say and using the [DDM](https://en.wikipedia.org/wiki/Dividend_discount_model) we know that

$P\_{t=4} = \frac{D\_{t=5}(1+g)}{r-g}$

Via the above equation, it is **assumed** that from year $5$, dividends will annually grow at a $g$ rate and that investors' required rate will be $r$, both forever. Since this calculation is nothing but a **simplification** (future growth and return rates will *a fortiori* change, etc...), we will not do more complicated.

Taking into account the share of debt in the capital structure of the company, say $X\%$, we can compute the average cost of capital (average over equity and debt), $r'$, needed to discount $P\_{t=4}$. One may **have an idea** of $X$ or **make assumptions** about it. It follows that $r'$ is such that

$r' = X\% r\_D + (1-X\%) r$

where $r\_D$ is the interest rate or the cost of debt (naturally [$r\_S < r$](https://en.wikipedia.org/wiki/Cost_of_capital)). Thus the company's IPO may be valued by involving that

$P\_{t=0} = \frac{P\_{t=4}}{(1+r')^4}$

Finally, as you can see there are **many assumptions** in this valuation, which is the job of experts, with the most fundamental about $D\_{t=5}$.

> **Comments:**
> **username_3**: Any question @username_0 ?  

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