imported>Doug Williamson |
imported>Doug Williamson |
Line 1: |
Line 1: |
| ''Equity valuation and cost of capital''
| | The probability-weighted average (i.e. arithmetic mean of the distribution) of possible future cash flows. |
|
| |
|
| (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.
| | ==See also== |
| | | *[[IFRS 13]] |
| | | *[[Fair value]] |
| ==Applications of the DGM==
| | *[[Cash flow]] |
| | | *[[Expected value]] |
| 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 == | |
| * [[Cost of equity]] | |
| * [[Corporate finance]] | |
| * [[Ex dividend]] | |
| * [[Perpetuity]] | |
| | |
| | |
| ==Student article==
| |
| [[Media:2013_10_Oct_-_The_real_deal.pdf| The real deal, The Treasurer]]
| |
| | |
| ''Real rates of corporate decline often lead to miscalculation, overpaying for acquisitions and disastrous losses.''
| |
| | |
| ''This article shows how to avoid the most common errors, save money and earn valuable exam marks.''
| |
| | |
| [[Category:Corporate_finance]]
| |