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cost of equity thfrough dividend model

+3 Votes
cost of equity thfrough dividend model

F9 and P4: to calculate the cost of equity through dividend model, the fomula is (Dividend of 1/Price of 0)+growhth rate, i wonder why it's not (Dividend of 1/Price of 0)*(1+growhth rate) ?

May 2nd 2014 AN ACCA USER 420 Points

2 Replies

+4 Votes

Hey... Well the cost of equity through dvm is derived through the business valuation of via dvm.

The formula : price of year 0 = dividend year 0 (1+growth) / cost of equity - growth is used.

Try making it the formula for Ke.
This will be Ke - growth = dividend year 0 (1+ growth) / price of year 0
Take the growth deducted from Ke to the other side, it will get added so now

Ke = dividend year 0 (1+g) / price of 0 + growth rate.
Now you would ask why I'm doing div year (1+g)
That's the same thing as dividend of year 1, if it's given don't do 1+g just directly put in the formula.

Interestingly this is derived from the perpetuity formula itself, that is 1/ discount rate x dividend saying that dividends will be given in perpetuity.

If what you wonder is applied then it will not be correct as you are adding too much growth. Try saying sales increased by 5% and sales increased by 105% (1+growth) there's a huge difference and therefore wrong. Hope this answers the question and didn't make things more complex :P

May 2nd 2014 AN ACCA USER 810 Points
Selected May 2nd 2014 AN ACCA USER
0 Votes
thanks so much, i almost forgot the perpetuity formula. thanks, i got it.
May 2nd 2014 AN ACCA USER 420 Points
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