Dividend growth model: Difference between revisions
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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. | ||
==Applications of the DGM== | |||
Common applications of the dividend growth model include: | |||
(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 | ||
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==DGM formulae== | |||
The DGM is commonly expressed as a formula in two different forms: | |||
Ke = D<sub>1</sub> / P<sub>0</sub> + g | Ke = D<sub>1</sub> / P<sub>0</sub> + g | ||
'' | ''or (rearranging the formula)'' | ||
P<sub>0</sub> = D<sub>1</sub> / ( Ke - g ) | P<sub>0</sub> = D<sub>1</sub> / ( Ke - g ) | ||
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Where: | ''Where:'' | ||
D<sub>1</sub> = expected dividend at future Time 1 = $10m. | D<sub>1</sub> = expected dividend at future Time 1 = $10m. | ||
Revision as of 18:10, 2 December 2015
(DGM).
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.
Applications of the DGM
Common applications of the dividend growth model include:
(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.
DGM formulae
The DGM is commonly expressed as a formula in two different forms:
Ke = D1 / P0 + g
or (rearranging the formula)
P0 = D1 / ( Ke - g )
Where:
P0 = ex-dividend equity value today.
D1 = expected future dividend at Time 1 period later.
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.
Example 1: Market value of equity
Calculating the market value of equity.
Where:
D1 = expected dividend at future Time 1 = $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 )
= 10 / ( 0.10 - 0.02 )
= 10 / 0.08
= $125m.
Example 2: Cost of equity
Or alternatively calculating the current market cost of equity using the rearranged formula:
Ke = D1 / P0 + g
Where:
D1 = expected future dividend at Time 1 = $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 = 10 / 125 + 2%
= 10%.
Also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model.
See also
