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X is an unquoted company.
Dividend will be $5m for each of the next 3 years and then expected to grow at 3% thereafter.
Similar company has earning yield of 12% and cost of equity 14%
Question: Calculate value of X using dividend valuation model.
Answer: MV = PV of future dividends discount discounted at Ke 14%
I am confused and was thinking MV = $5m/0.14, as there is no growth in the next year.
Can you explain where did i get it wrong?
You really must watch my free lectures on the valuation of shares!
The market value depends on the expectation of all futures dividends. There no growth for the first three years, and so you need to discount them as normal. There is growth afterwards and for the growing dividends you need to use the dividend valuation formula.
You are simply assuming that the dividend remains constant for ever!!
In my lectures I explain this and work through examples (including examples similar to the one you have written, which is commonly asked in the exam).
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