Dividend Discount

8/7/2019 Dividend Discount

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BY

RAMAN

SURAJITRAJESH

PRIYANKA


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` Single-period Valuation model

` Expected Rate of Return

` Multi-period Valuation model


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` Here the investor expects to hold the security for 1year.

` To find out the price of the equity share after 1

year the formula is:

P=D/(1+r) + P/(1+r)Where, P=current price of the equity.

D=dividend expected a year hence

P=price of the share after a year

r=rate of return


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` The expected rate of return isr=D/P +g

Where, D=expected dividend.

P=current price of the share.

g=growth rate.


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` Equity shares have no maturity period.` The investor may be expected to bring a dividend

stream of infinite time.` Then the value of an equity will be:P=D/(1+r)+D/(1+r)+..+Dn/(1+r)

+Pn/(1+r)Where, D=expected rate of dividend after a year.

D=expected dividend after 2 year.r=expected return.

n=no. of year of holding the security.Pn=selling price after n year.


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` Zero Growth Model.` Constant Growth Model(Gordon model).

` Two stage Growth Model.

` H Model.


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` The dividend per share remain constant year afteryear.

` The price of the equity will be:

P=D/r

Where, D=dividend per year.

r=rate of return.


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` The popular dividend discount model originally

proposed by Myron.J.Gordon.

` In this model the assumption is that the dividend

per share grows at a constant rate.` The price of the equity will be;

P=D/(r-g)

Where, D=dividend after 1 year.

r=rate of return.

g=growth rate per year.


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`

It is the simplest extension of constant growth model.` It assumes that the extraordinary growth will continue

for finite no. of years and then normal growth rate will

prevail indefinitely.

So, P=D[{1-(1+g)/(1+r)}/(r-g)] +[{D(1+g)(1+g)}/(r-g)] * [1/(1+r)]

Where, D=dividend after a year.

g,g=growth rate of 1st & 2nd period

respectively.r=rate of return.

n=no. of year of the 1st period.


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`

The current dividend on an equity share is Rs.2of Altd. A ltd expected an above-normal growth rate of

20% for a period of 6 year. Thereafter the growth rate

will 10%.the rate of return 15%.

Here ,g=20%,g=10%,n=6year,r=15year,D=Rs.2(1.2)=Rs.2.40.

P=2.40[{1-(1.20/1.15)}/(.15-.2)] +

[{2.40(1.2)(1.1)}/(.15-.10)] * (1/(1.15)2

=Rs.70.76


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The value of the equity will be:P=D[(1+gn)+H(ga-gn)]/(r-gn)

Where, D=current dividend per share.

gn=normal long run growth rate.

ga=current above-normal growth rate.H=one half of the period which current above-

normal growth rate will level off to normal long run

growth rate.


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`

The value of a stock under this approach isP=E*P/E

Where, E=estimated earning per share.

P/E=price-earning ratio=(1-b)/(r-g)


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Thumb rule1:The price earnings multiple for a

share may be equated with the projected growth

rate in earnings.

Thumb rule2:For the market as a whole, a

reasonable price-earning multiple would be the

inverse of the prime interest.

Thumb rule3:For the market as a whole, a

reasonable price-earning multiple would be the

inverse of the real rate of return required by

investors from equity stocks.


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Dividend Discount