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why is the dividend growth subtracted from the shareholders required rate of return? that is Re-g
The only real way to explain would be to prove the formula, which cannot be required in the exam.
(Although if you are OK at maths it is actually quite easy to prove if you are happy with dealing with inflation in investment appraisal and discounting the current price flows at the real cost of capital – because the formula is calculating the PV of the growing dividends, because that is the MV. However, you would be wasting your time trying to prove it – the formula is given to you and you are just expected to be able to use it.)However, although not a proof, there is some obvious logic. If dividends were not growing then you would get the MV by simply dividing the dividend by Re.
If dividends are expected to grow, then you would expect a higher MV, and dividing the dividend by (Re – g) will result in a higher MV.
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