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Dividend Discount Model

The dividend discount model values a stock based on the present value of expected future dividends plus the present value of the stock's expected sale price. There are single-period, multi-period, zero growth, constant growth, two-stage growth, and H models that make assumptions about dividend growth rates. Higher expected dividend growth leads to higher stock prices, lower dividend yields, higher capital gains yields, and higher price-earnings ratios for a given required return. Growth prospects influence these valuation ratios.

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Ankita Patel
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18 views

Dividend Discount Model

The dividend discount model values a stock based on the present value of expected future dividends plus the present value of the stock's expected sale price. There are single-period, multi-period, zero growth, constant growth, two-stage growth, and H models that make assumptions about dividend growth rates. Higher expected dividend growth leads to higher stock prices, lower dividend yields, higher capital gains yields, and higher price-earnings ratios for a given required return. Growth prospects influence these valuation ratios.

Uploaded by

Ankita Patel
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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DIVIDEND

DISCOUNT
MODEL
According to the dividend discount
model,
The value of an equity share = present value
of dividends expected from its ownership +
present value of the sale price expected when
the equity share is sold.
Assumptions under dividend
discount model:
 Dividends are paid annually.
 The first dividend is received one year after
the equity share is bought.
SINGLE PERIOD VALUATION
MODEL
In this case the investor expects to hold the equity share for 1
year.

Po = D1/(1+r) + P1/(1+r).
Where
P0 =current price of the equity share.
D1 =dividend expected a year.
P1 = price of the share expected a year.
r = rate of return required on the equity share.
EXPECTED RATE OF RETURN

In this case the investor calculate the intrinsic


value of an equity share, given information
about
1)the forecast values of dividend and share
price, and
2)the required rate of return.
Expected rate of return is equal to:
r = D1/Po + g.
MULTI- PERIOD VALUATION
MODEL

Since equity shares have no maturity period,


they may be expected to bring a dividend
stream of infinite duration.
P0 = D1 / ( 1 + r ) + D2 / ( 1 + r )2 + …. + D∞ / ( 1 +
r )∞

Where
• P0 is the current price of the equity share,
• D1 is the dividend expected a year hence,
• D2 is the dividend expected two years hence,
• D∞ is the dividend expected at the end of infinity, and
• R is the rate of return required the equity share on.
ZERO GROWTH MODEL
If we assume that the dividend per share
remains constant year after year at a value of D,
equation becomes:

P0 = D / ( 1 + r ) + D / ( 1 + r )2 + …. + D / ( 1 + r )
+ …. + D / ( 1 + r )∞

Equation on simplification becomes:


P0 = D / r
CONSTANT GROWTH MODEL
(GORDON MODEL)

Here we have to assume that the dividend per


share grows at a constant rate (g). The value of
the share under this assumption is,

P0 = D1 / ( 1 + r ) + D1( 1 + g ) / ( 1 + r )2 + ….

+ D1( 1 + g )n / ( 1 + r )n+1 + ….
TWO STAGE GROWTH
MODEL
Here the dividend per share grows at a
constant extraordinary rate for a finite period,
followed by a constant normal rate of growth
forever thereafter.

P0 =[D1/ 1 + r) + D1(1 +g1 )/(1 + r)2 + D1(1 + g1)2/(1 +


r)3 +…+ D1(1 + g1)n-1/(1 + r)n] + Pn /(1+ r)n
Where
P0 = current price of the equity share.
D1 = dividend expected a year.
g 1 = the extraordinary growth rate applicable
for n years.
Pn = the price of the equity share at the end of
yearn.
H MODEL

Here the dividend per share, currently


growing at an above-normal rate, experiences
a gradually declining rate of growth for a
while and thereafter, it grows at a constant
normal rate.
ASSUMPTIONS UNDER H
MODEL
 While the current dividend growth rate, g a, is
greater than gn the normal log run growth rate
declines linearly for2H years.
 After 2H years the growth rate becomes g n.
 At H years the growth rate is exactly halfway
between ga and gn.
The valuation equation for the H MODEL:
Po = DO(1+gn) + H(ga – gn)/r – gn.
Where
Po = the intrinsic value of the share.
Do = the current dividend per share.
r = the rate of return expected by investors.
gn = the normal long – run growth rate.
ga = the current above - normal growth rate.
H = the one-half of the period during which ga will level off
to ga
IMPACT OF GROWTH ON PRICE, RETURNS, AND P/E RATIO

 The expected growth rates of companies differ


widely.
 Assuming a constant total required return,
differing expected growth rates mean differing
stock prices, dividends yields, capital gains
yields, and price-earnings ratios.
THE RESULT OF GROWTH
It suggest the following points:
 As the expected growth in dividend increases,
other things being equal, the expected return
depends more on the capital gains yield and
less on the dividends yield.
 As the expected growth in dividend increases,
other things being equal, the price-earnings
ratio increases.
 High dividend yield and low price-earnings
ratio imply limited growth prospects.

 Low dividend yield and high price-earnings


ratio imply considerable growth prospects.
GROUP MEMBERS:

• ANKITA PATEL 88

• RASIKA SHIRODKAR 94

• SHWETA DOBRA 95

• SUKESHINI SALVI

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