Dividend growth model: Difference between revisions
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''Equity valuation and cost of capital''. | |||
(DGM). | (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. | |||
==Applications of the DGM== | |||
Common applications of the dividend growth model include: | |||
(1) Estimating the market <u>cost of equity</u> from the current share price; and | (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. | (2) Estimating the fair <u>value</u> of equity from a given or assumed cost of equity. | ||
Where: | ==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. | P<sub>0</sub> = ex-dividend equity value today. | ||
D<sub>1</sub> = expected dividend at Time 1 period | |||
D<sub>1</sub> = expected future dividend at Time 1 period later. | |||
Ke = cost of equity per period. | Ke = cost of equity per period. | ||
g = constant periodic rate of growth in dividend from Time 1 to infinity. | 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. | 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: | Or alternatively calculating the current market <u>cost of equity</u> using the rearranged formula: | ||
D<sub>1</sub> = expected dividend at Time 1 | Ke = (D<sub>1</sub> / P<sub>0</sub>) + g | ||
P<sub>0</sub> = current market value of equity | |||
g = constant periodic rate of growth in dividend from Time 1 to infinity = 2% | |||
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 == | == See also == | ||
* [[Capital asset pricing model]] | |||
* [[Cost of equity]] | * [[Cost of equity]] | ||
* [[ | * [[Corporate finance]] | ||
* [[Discounted cash flow]] | |||
* [[Ex-dividend]] | |||
* [[Growing perpetuity factor]] | |||
* [[Model]] | |||
* [[Perpetuity]] | * [[Perpetuity]] | ||
* [[Perpetuity factor]] | |||
==The Treasurer 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]] | |||
Latest revision as of 21:05, 4 July 2022
Equity valuation and cost of capital.
(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.
Applications of the DGM
Common applications of the dividend growth model include:
(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.
DGM formulae
The DGM is commonly expressed as a formula in two different forms:
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, 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
- Discounted cash flow
- Ex-dividend
- Growing perpetuity factor
- Model
- Perpetuity
- Perpetuity factor
The Treasurer article
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.
