Describe, compare and contrast the following ordinary share dividend valuation models: (i) zero growth, (ii) constant...

Describe, compare and contrast the following ordinary share dividend valuation models: (i) zero growth, (ii) constant growth, and (iii) variable growth.

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Expert Solution

Dividend discount model is a model where to calculate the price of a stock we discount the expected dividend for all future years and calculate their present value today. The formula for price of a stock according to dividend discount model is,

Price = Current dividend *(1+ growth rate)/ (required rate- growth rate)

When the growth rate is 0, the growth rate would be 0 and effectively the formula for price of the stock would be equivalent to formula of a perpetuity cash flow. It would be current dividend divided by the required rate.

When the growth rate is constant the price of the stock would be equivalent to expected dividend divided by the difference between the required rate and growth rate. This is still an easy approach to calculate the value of the stock but if the growth rate is higher than the required rate then this formula cannot be applied.

When the growth rate is variable then it is slightly complex to value the stock. First, we have to calculate the dividend for each year in which the growth rate is variable and then we have to calculate the terminal value from the year onwards in which the growth rate becomes constant and then we would discount them to their present value.

jeff jeffy answered 1 year ago

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