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Chapter 6

2.3 The dividend valuation model (DVM), or ‘Growth model’

Theory: The value of a share is the present value of the expected
future dividends discounted at the shareholders’ required rate of return.

Assuming a constant growth rate in dividends:

P 0 = D 0(1 + g)/(k e – g)

(this formula is given on the formula sheet)

Where kₑ = cost of equity

Dₒ = current dividend

Pₒ = market price of a share

g = constant rate of growth in dividends

 If we need to derive k e the formula can be rearranged to:

k e = [D 0 (1 + g)/P 0 ] + g

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