Dividend growth model: Difference between revisions
imported>Doug Williamson (Make timing of Time 1 future dividend explicit.) |
imported>Doug Williamson (Colour example labels.) |
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'''Example 1''' | <span style="color:#4B0082">'''Example 1'''</span> | ||
Calculating the market <u>value</u> of equity. | Calculating the market <u>value</u> of equity. | ||
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'''Example 2''' | <span style="color:#4B0082">'''Example 2'''</span> | ||
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: | ||
Revision as of 13:16, 13 November 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.
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 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
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
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.
