A corporation will pay an annual dividend of $0.65 one year from now. Analyst expects this dividend to grown 12.9% per year thereafter until the fifth year. After then, growth will level off at 1.9% per year. According to the dividend discount model what is the value of the share if the firm’s equity cost of capital is 8.1%
To calculate the value of a share using the dividend discount model (DDM), we need to use the following formula:
Value of the Share = Dividend/(1 + Cost of Capital) + Dividend/(1 + Cost of Capital)^2 + Dividend/(1 + Cost of Capital)^3 + ... + Dividend/(1 + Cost of Capital)^n
Where:
- Dividend: Annual dividend payment
- Cost of Capital: Equity cost of capital
- n: Number of years
Let's break down the information given in the question and calculate the value of the share.
1. Dividend in Year 1: $0.65
2. Dividend growth rate:
- 12.9% per year until the fifth year
- 1.9% per year after the fifth year
3. Equity cost of capital: 8.1%
Now, we can calculate the value of the share by discounting the expected dividends at the equity cost of capital and summing them up.
Value of the Share = $0.65/(1 + 0.081) + $0.65/(1 + 0.081)^2 + $0.65/(1 + 0.081)^3 + ... + $0.65/(1 + 0.081)^n
We need to sum the dividends for each year until the fifth year and then continue with the flat 1.9% growth rate.
Now, you can calculate the value of the share by plugging in the numbers and using a financial calculator or spreadsheet.