What discount rate is used in a Dividend Discount Model (DDM) instead of WACC?

In a Dividend Discount Model (DDM), the discount rate used is the Cost of Equity. The DDM specifically focuses on valuing a company based on the present value of its expected future dividends, which are payments made to shareholders. Since dividends are paid to equity holders, it is appropriate to use the cost of equity as the discount rate.

The cost of equity represents the return that equity investors require for investing in the company. This is different from the Weighted Average Cost of Capital (WACC), which averages the costs of both equity and debt financing based on their proportions in the overall capital structure. In scenarios where dividends are involved, particularly when assessing equity value, using the cost of equity allows for a clearer reflection of the risk and return demands of equity shareholders.

This makes the DDM distinct in its methodology compared to other valuation approaches that might utilize WACC, which accounts for the entire capital structure. Thus, in the context of the DDM, the focus on equity outcomes specifically justifies the use of the cost of equity as the appropriate discount rate.