Regarding growth model — OpenTuition Forums

Jjulianleong4y ago

Hi John, In the growth model, to get the Ke with dividend growth, the formula is D0(1+g)/Po + g. T1 dividend (1+g) is a point in time as with T0 (1). It is just two static numbers for terminal value calculation. At the same price, T1/Po will be higher than T0/Po. However, the dividend is growing and we need to account for it. Therefore, I understand why the growth needs to be added to the Ke (if price remains the same). e.g. T1/P0 + g How can we proof this mathematically that the growth (say 6%) translate exactly to the Ke (e.g. T1/P0 + 6%)

John MoffatTutor4y ago#1

You use an iterative proof. If the rate of growth is g and the discount rate is Ke, then Po = D(1+g)/(1+Ke) + D ((1+g)/(1+Ke))^2 and so on to infinity. You multiply throughout by (1+g)/(1+Ke), and then solve the two equations together. If you have studied this arithmetic before then it is a very easy proof. Otherwise do not waste your time because you cannot be asked to prove it which is why you are given the formula in the exam.

Jjulianleong4y ago#2

Thanks John. This is just for my own understanding. Really appreciate your help!

John MoffatTutor4y ago#3

You are welcome.

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