Question

Write out the formula for the constant growth dividend valuation model. What key assumptions are required?

You are interested in buying a share that paid its last annual dividend 9 months ago. You can assume that the next dividend payment (3 months from today) will be €1.50. The company anticipates that dividend growth rates will be 5% annually for the next two dividends and 2% thereafter. Assuming the firm’s cost of equity rE is 9%, how much should you pay for the share?

Answer 1

Constant growth dividend model :
Price =D1/(r-g) where r is the required return and g is the constant growth rate.
The assumptions are :
The company is a going concern
The rate is constant for both growth and required return over all the years
The growth rate shall not be equal to the required return

Year	Div	Terminal value	DF	PV
0			1
1	1.5		0.917431	$       1.38
2	1.575		0.84168	$       1.33
3	1.65375	24.0975	0.772183	$    19.88
4	1.686825		0.708425
			Price	$    22.59

Now this is the price we have caclulated at year =0 which is 9 months before today
Hence today one shall pay = 22.59*(1.09^(9/12))=$24.11