Diversification and Dividend growth model: Difference between pages
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(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. | |||
Its most common uses are: | |||
(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. | |||
''Expressed as a formula:'' | |||
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 per period = $125m. | |||
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%. | |||
Ke = 10 / 125 + 2% | |||
= '''10%.''' | |||
Also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model. | |||
== See also == | == See also == | ||
* [[ | * [[CertFMM]] | ||
* [[ | * [[Cost of equity]] | ||
* [[ | * [[Corporate finance]] | ||
* [[ | * [[Perpetuity]] | ||
==Other resources== | |||
[[Media:2013_10_Oct_-_The_real_deal.pdf| The real deal, The Treasurer student article]] | |||
[[Category: | [[Category:Corporate_finance]] | ||
Revision as of 14:15, 2 December 2015
(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.
Its most common uses are:
(1) Estimating the market cost of equity from the current share price; and
(2) Estimating the fair value of equity from a given or assumed cost of equity.
Expressed as a formula:
Ke = D1 / P0 + g
OR (rearranging the formula)
P0 = D1 / ( Ke - g )
Where:
P0 = ex-dividend equity value today.
D1 = 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.
Example 1: Market value of equity
Calculating the market value of equity.
Where:
D1 = 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%.
P0 = D1 / ( Ke - g )
= 10 / ( 0.10 - 0.02 )
= 10 / 0.08
= $125m.
Example 2: Cost of equity
Or alternatively calculating the current market cost of equity using the rearranged formula:
Ke = D1 / P0 + g
Where:
D1 = expected future dividend at Time 1 = $10m.
P0 = current market value of equity per period = $125m.
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2%.
Ke = 10 / 125 + 2%
= 10%.
Also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model.
See also
