imported>Doug Williamson |
imported>Doug Williamson |
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| (DGM).
| | The risk that contracts or business relationships may have unforeseen adverse legal consequences as a result of the way in which they are documented. |
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| 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 example is borrowings documentation. |
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| Its most common uses are:
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| (1) Estimating the market <u>cost of equity</u> from the current share price; and
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| (2) Estimating the fair <u>value</u> of equity from a given or assumed cost of equity.
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| Expressed as a formula:
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| Ke = D<sub>1</sub> / P<sub>0</sub> + g
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| ''OR (rearranging the formula)''
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| P<sub>0</sub> = D<sub>1</sub> / ( Ke - g )
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| Where:
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| P<sub>0</sub> = ex-dividend equity value today.
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| D<sub>1</sub> = expected dividend at Time 1 period hence.
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| Ke = cost of equity per period.
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| g = constant periodic rate of growth in dividend from Time 1 to infinity.
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| This is an application of the general formula for calculating the present value of a growing perpetuity.
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| '''Example 1'''
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| Calculating the market <u>value</u> of equity.
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| Where:
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| D<sub>1</sub> = expected dividend at Time 1 period hence = $10m.
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| Ke = cost of equity per period = 10%.
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| g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%.
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| P<sub>0</sub> = D<sub>1</sub> / ( Ke - g )
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| = 10 / ( 0.10 - 0.02 )
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| = 10 / 0.08
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| = $125m.
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| '''Example 2'''
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| Or alternatively calculating the current market <u>cost of equity</u> using the rearranged formula:
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| Ke = D<sub>1</sub> / P<sub>0</sub> + g
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| Where:
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| D<sub>1</sub> = expected dividend at Time 1 period hence = $10m.
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| P<sub>0</sub> = current market value of equity per period = $125m.
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| g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%.
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| Ke = 10 / 125 + 2%
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| = 10%.
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| Also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model.
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| == See also == | | == See also == |
| * [[CertFMM]] | | * [[Acceleration]] |
| * [[Cost of equity]] | | * [[Documentation]] |
| * [[Corporate finance]] | | * [[Loan Market Association]] |
| * [[Perpetuity]]
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| [[Category:Corporate_finance]] | | [[Category:Treasury_operations_infrastructure]] |
