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''Equity valuation and cost of capital''
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(DGM).  
A business with a small share of a market with slow (or negative) growth.


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.


2.


==Applications of the DGM==
A poorly performing business or product.
 
Common applications of the dividend growth model include:
 
(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.
 
 
==DGM formulae==
 
The DGM is commonly expressed as a formula in two different forms:
 
Ke = (D<sub>1</sub> / P<sub>0</sub>) + g
 
''or (rearranging the formula)''
 
P<sub>0</sub> = D<sub>1</sub> / (Ke - g)
 
 
''Where:''
 
P<sub>0</sub> = ex-dividend equity value today.
 
D<sub>1</sub> = 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.
 
 
 
<span style="color:#4B0082">'''Example 1: Market value of equity'''</span>
 
Calculating the market <u>value</u> of equity.
 
 
''Where:''
 
D<sub>1</sub> = 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%.
 
 
P<sub>0</sub> = D<sub>1</sub> / (Ke - g)
 
= 10 / (0.10 - 0.02)
 
= 10 / 0.08
 
= $'''125'''m.
 
 
 
<span style="color:#4B0082">'''Example 2: Cost of equity'''</span>
 
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
 
 
Where:
 
D<sub>1</sub> = expected future dividend at Time 1 = $10m.
 
P<sub>0</sub> = current market value of equity, ex-dividend = $125m.
 
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%.
 
 
Ke = (10 / 125) + 2%
 
= 8% + 2%
 
= '''10%.'''
 
 
The dividend growth model is also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model.




== See also ==
== See also ==
* [[Cost of equity]]
* [[Boston Matrix]]
* [[Corporate finance]]
* [[Cash cow]]
* [[Ex dividend]]
* [[Problem child]]
* [[Perpetuity]]
* [[Star]]
 
 
==Student article==
[[Media:2013_10_Oct_-_The_real_deal.pdf| The real deal, The Treasurer]]
 
[[Category:Corporate_finance]]

Revision as of 12:31, 22 June 2016

1.

A business with a small share of a market with slow (or negative) growth.


2.

A poorly performing business or product.


See also