Dividend growth model and Expected cash flow: Difference between pages

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''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]]

Revision as of 17:38, 26 July 2015

The probability-weighted average (i.e. arithmetic mean of the distribution) of possible future cash flows.


See also