Question

an assessment of the merits and pitfalls of using the dividend growth model to estimate the stock price of a non-dividend-paying stock. In your assessment, do the following: Compare and contrast how the variables in the dividend growth model affect the valuation of a dividend-paying stock and a non-dividend-paying stock. Include information from the company you located to support your assessment.

Answer 1

Dividend Growth Model used to claculate the fair price of share by using growth rate. This model work on caertain assumptions:

(i) Infinite life of stock

(ii) Dividend rate is regular and constant

Dividend growth model is mostly used in companies which pays dividend on regular basis and at a constant rates. For low or no dividend paying companies, the model may prove inappropriate since the model bases its assumptions that the company growth will be constant.

Current Price of stock = D₁ / (k_e - g)

where D₁ = Dividend for coming year

K = required rate of return ; K_e must be greater than g if K_e is less than g then current price will be -ve

g = growth rate of dividend

A non dividend paying company can use this model to estimate the fair value by making an educated guess on the future dividends and applying some margin of error.