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Unformatted text preview: set Pricing Model ks = kRF + (kM – kRF) β The Dividend Growth Model The Dividend Growth Model Approach Start with the dividend growth model formula and rearrange to solve for RE D1 P= 0 K s −g D1 Ks = +g P 0 Dividend Growth Model Dividend Growth Model Example Suppose that your company is expected to pay a dividend of $1.50 per share next year. There has been a steady growth in dividends of 5.1% per year and the market expects that to continue. The current price is $25. What is the cost of equity? 1.50 Ks = + .051 = .111 = 11.1% 25 Dividend Growth Model Dividend Growth Model Example If D0 = $4.19, P0 = $50, and g = 5%, what’s the cost of common equity based upon the DGM approach? D1 D1 D1 = D0 (1+g) = $4.19 (1 + .05) = $4.3995 ks = D1 / P0 + g = $4.3995 / $50 + 0.05 = 13.8% Example: Estimating the Dividend Example: Estimating the Dividend Growth Rate (g) What is the expected future growth rate? 1. Use ROE and Payout ratio The firm has been earning 15% on equity (ROE = 15%) and retaining 35% of its earnings (dividend payout = 65%). This situation is expected to...
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This document was uploaded on 01/14/2014.

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