Disequilibrium unemployment and Dividend growth model: Difference between pages
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'' | ''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 <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 per period = $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 == | ||
* [[ | * [[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 23:13, 21 November 2016
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 per period = $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