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Z has 10,000 shares in issue, dividends for the next five years are expected to be constant at 10 cents per share and then grow at 5% per year to perpetuity. Cost of equity is 15%.
How shall the market value be calculated…?
Secondly, dividend growth model assumes that dividend paid is until infinity. Is this correct…?
Market value is the present value of future expected dividends discounted at shareholders required rate of return.
So for the first 5 years, you need to discount 10c per year using the 5 year annuity factor at 15%.
Once growth starts you use the dividend growth formula with D = 10c; g = 5%; and R = 15%.
However, because the first dividend will be at time 6 instead of as usual time 1, it means everything is 5 years late and so you need to discount the answer from the growth model formula for 5 years at 15%.The growth model assumes that shareholders expect the dividend to continue in perpetuity – i.e. to infinity. (It is their expectations that determine the market value).
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