Dividend growth model: Difference between revisions
imported>Doug Williamson m (Replace underscore in Corporate finance link, with space.) |
imported>Doug Williamson (Updated entry. Source ACT Glossary of terms) |
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The Dividend growth model links the value of a firm’s equity and its market cost of equity by modelling the expected future dividends receivable by the shareholders as a constantly growing perpetuity. | The Dividend growth model links the value of a firm’s equity and its market cost of equity by modelling the expected future dividends receivable by the shareholders as a constantly growing perpetuity. | ||
Its most common uses are: | Its most common uses are: | ||
(1) Estimating the market <u>cost of equity</u> from the current share price; and | (1) Estimating the market <u>cost of equity</u> from the current share price; and | ||
(2) Estimating the fair <u>value</u> of equity from a given or assumed cost of equity. | (2) Estimating the fair <u>value</u> of equity from a given or assumed cost of equity. | ||
Expressed as a formula: | Expressed as a formula: | ||
Ke = D<sub>1</sub>/P<sub>0</sub> + g | Ke = D<sub>1</sub>/P<sub>0</sub> + g | ||
''OR (rearranging the formula)'' | ''OR (rearranging the formula)'' | ||
P<sub>0</sub> = D<sub>1</sub>/[Ke-g] | P<sub>0</sub> = D<sub>1</sub>/[Ke-g] | ||
Where: | Where: | ||
P<sub>0</sub> = ex-dividend equity value today. | P<sub>0</sub> = ex-dividend equity value today. | ||
D<sub>1</sub> = expected dividend at Time 1 period hence. | D<sub>1</sub> = expected dividend at Time 1 period hence. | ||
Ke = cost of equity per period. | Ke = cost of equity per period. | ||
g = constant periodic rate of growth in dividend from Time 1 to infinity. | g = constant periodic rate of growth in dividend from Time 1 to infinity. | ||
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'''2.''' | '''2.''' | ||
For example calculating the market <u>value</u> of equity: | For example calculating the market <u>value</u> of equity: | ||
D<sub>1</sub> = expected dividend at Time 1 period hence = $10m | D<sub>1</sub> = expected dividend at Time 1 period hence = $10m | ||
Ke = cost of equity per period = 10% | Ke = cost of equity per period = 10% | ||
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2% | g = constant periodic rate of growth in dividend from Time 1 to infinity = 2% | ||
P<sub>0</sub> = D<sub>1</sub>/[Ke-g] | P<sub>0</sub> = D<sub>1</sub>/[Ke-g] | ||
= $10m/[0.10 - 0.02 = 0.08] | = $10m/[0.10 - 0.02 = 0.08] | ||
= <u>$125m.</u> | = <u>$125m.</u> | ||
'''3.''' | '''3.''' | ||
Or alternatively calculating the current market <u>cost of equity</u> using the rearranged formula: | Or alternatively calculating the current market <u>cost of equity</u> using the rearranged formula: | ||
Ke = D<sub>1</sub>/P<sub>0</sub> + g | Ke = D<sub>1</sub>/P<sub>0</sub> + g | ||
D<sub>1</sub> = expected dividend at Time 1 period hence = $10m | D<sub>1</sub> = expected dividend at Time 1 period hence = $10m | ||
P<sub>0</sub> = current market value of equity per period = $125m | P<sub>0</sub> = current market value of equity per period = $125m | ||
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2% | g = constant periodic rate of growth in dividend from Time 1 to infinity = 2% | ||
Ke = $10m/$125m + 2% | Ke = $10m/$125m + 2% | ||
= <u>10%.</u> | = <u>10%.</u> | ||
Revision as of 16:02, 19 November 2014
(DGM).
1.
The Dividend growth model links the value of a firm’s equity and its market cost of equity by modelling the expected future dividends receivable by the shareholders as a constantly growing perpetuity.
Its most common uses are:
(1) Estimating the market cost of equity from the current share price; and
(2) Estimating the fair value of equity from a given or assumed cost of equity.
Expressed as a formula:
Ke = D1/P0 + g
OR (rearranging the formula)
P0 = D1/[Ke-g]
Where: P0 = ex-dividend equity value today.
D1 = expected dividend at Time 1 period hence.
Ke = cost of equity per period.
g = constant periodic rate of growth in dividend from Time 1 to infinity.
This is an application of the general formula for calculating the present value of a growing perpetuity.
2.
For example calculating the market value of equity:
D1 = expected dividend at Time 1 period hence = $10m
Ke = cost of equity per period = 10%
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%
P0 = D1/[Ke-g]
= $10m/[0.10 - 0.02 = 0.08]
= $125m.
3.
Or alternatively calculating the current market cost of equity using the rearranged formula:
Ke = D1/P0 + g
D1 = expected dividend at Time 1 period hence = $10m
P0 = current market value of equity per period = $125m
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%
Ke = $10m/$125m + 2%
= 10%.
Also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model.
