imported>Doug Williamson |
imported>Administrator |
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| ''Equity valuation and cost of capital''
| | In financial theory dividend payments and policies should be irrelevant when financial markets are efficient. |
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| (DGM).
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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.
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| ==Applications of the DGM==
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| Common applications of the dividend growth model include:
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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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| ==DGM formulae==
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| The DGM is commonly expressed as a formula in two different forms:
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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 future dividend at Time 1 period later.
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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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| <span style="color:#4B0082">'''Example 1: Market value of equity'''</span>
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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 future Time 1 = $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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| = $'''125'''m.
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| <span style="color:#4B0082">'''Example 2: Cost of equity'''</span>
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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 future dividend at Time 1 = $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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| = 8% + 2%
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| = '''10%.'''
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| The dividend growth model is also known as the Dividend discount model, the Dividend valuation model or the Gordon growth model.
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| | But in practice decisions about dividend levels are important because of their informational content. This informational content is known as ''signalling''. |
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| == See also == | | == See also == |
| * [[Cost of equity]] | | * [[Lintner]] |
| * [[Corporate finance]] | | * [[Residual theory]] |
| * [[Perpetuity]]
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| ==Other resources==
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| [[Media:2013_10_Oct_-_The_real_deal.pdf| The real deal, The Treasurer student article]]
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| [[Category:Corporate_finance]]
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