Dividend growth model and Mid-sized companies: Difference between pages

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''Equity valuation and cost of capital''.
Smaller, large companies.


(DGM).  
Often firms are classified as small, medium or large. Different definitions of the categories apply for different purposes and in different jurisdictions and in formal and informal use.


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.
A common grouping is [[Small and Medium-sized Enterprises]], SMEs. These may benefit from easier financial reporting requirements, tax provisions or eligibility for various government-provided supports.


Most firms are small, some are medium-sized and few are large. But the sizes of firms in the last category vary greatly. In European Union use, for example, SMEs do not exceed €43m in turnover while some companies turnover many billions. Of course, opportunities of many kinds available to firms, for example the available range of investment and financing opportunities, vary materially with their size.


==Applications of the DGM==
It has become useful to distinguish smaller large companies for some purposes.


Common applications of the dividend growth model include:
In the UK, the idea of Mid-sized companies, with turnover of up to £500m and of Mid+ sized companies with up to £1bn turnover has developed. By early 2015 the idea of mid-size has been taken up by some authors in euro-terms as a broad mid-sized company range up to €1.2bn turnover.


(1) Estimating the market <u>cost of equity</u> from the current share price; and
No doubt terminology will continue to develop until its use in law and regulation makes further change more difficult or confusing.
 
(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 ==
* [[Capital asset pricing model]]
* [[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 and add value for your organisation.''
 
[[Category:Corporate_finance]]
[[Category:Financial_products_and_markets]]

Revision as of 11:28, 16 February 2015

Smaller, large companies.

Often firms are classified as small, medium or large. Different definitions of the categories apply for different purposes and in different jurisdictions and in formal and informal use.

A common grouping is Small and Medium-sized Enterprises, SMEs. These may benefit from easier financial reporting requirements, tax provisions or eligibility for various government-provided supports.

Most firms are small, some are medium-sized and few are large. But the sizes of firms in the last category vary greatly. In European Union use, for example, SMEs do not exceed €43m in turnover while some companies turnover many billions. Of course, opportunities of many kinds available to firms, for example the available range of investment and financing opportunities, vary materially with their size.

It has become useful to distinguish smaller large companies for some purposes.

In the UK, the idea of Mid-sized companies, with turnover of up to £500m and of Mid+ sized companies with up to £1bn turnover has developed. By early 2015 the idea of mid-size has been taken up by some authors in euro-terms as a broad mid-sized company range up to €1.2bn turnover.

No doubt terminology will continue to develop until its use in law and regulation makes further change more difficult or confusing.