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Any students who are looking for answers for what is a dividend growth rate model? Do you want to learn the use of using a dividend growth rate model in the real world? Is working with numbers and formulae giving you a hard time? My Assignment Services is an accounting assignment help destination that can give answers to these problems. I am Julia Martin and I am going to tell you everything you need to know about dividend growth rate model to solve your assignments.
The dividend growth model is a valuation model. Using this model, the financial analysts and investors calculate the fair value of a stock and then decide if the stock is worth investing in or not. An important point you should remember here is that this model operates on the assumption that the dividends grow annually. That can be either at a stable rate constant for a long time or different rate is broken into smaller time periods.
See, whenever the company is paying dividends to the shareholders, it is available on the stock market. You know that, right? So, when a potential investor is looking to invest in a stock, they evaluate their options. They check if the stock’s dividends will grow in the near future or not and will the investor get a return for their investment? Do you understand this till here? So, there are two terms that we use in a dividend growth rate model. The first one is undervalued. An undervalued stock means the present value of the stock is more than the market value of the stock. The other one is overvalued. It means that the market values the stock for more than what it is worth. Or, the present value of the stock is less than the market value of the stock.
You do that by calculating the firm’s expected dividends and at what rate do they grow annually. This is the formula to calculate the current stock price, where - P = current stock price D = value of the dividend of the next year r = constant cost of equity capital for that company. In other words, the rate of return g = constant growth rate in perpetuity expected for the dividends
Of course, I can. You will understand everything quite clearly with an example. Imagine a company called Corporation A declares that it provides an annual dividend of $3 per share for the year. I am a financial analyst and Mr X wants me to calculate the fair value of the company’s stock and tell if the investment is worthwhile or not. I dig into the company’s records and see the past trends to see that the dividends for Corporation A grow at a constant rate of 6% in perpetuity. Also, the previous data reveals that the rate of return of the company is 13%. Therefore, the price of the stock is D = $3 r = 13% g = 6% P = $3/(13%-6%) = $3/7% = $42.86 This price, $42.86 is the present value of the stock as per the constant dividend growth rate model. If the stock market is selling the stocks of Corporation A for a price lower than $42.86, then the stock is undervalued and will be a good investment for Mr X. If the market price of the stock is greater than $42.86, then the stock is overvalued and an unwise decision for Mr X.
There are a few assumptions that govern this model. They are -
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Sofia is dedicatedly assisting students with their IT assignments for the past 13 years. With an understanding of information technology, she has worked with several IT organizations in Australia and USA to explore strategic and managerial issues raised from information technology management. After spending her tenure with large corporations, she switched to My Assignment Services. Sofia realized that what she has observed in the past years can help students excel in these disciplines. Hence, now she leads a team who assists students with their homework and achieve the best learning outcomes.
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