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Dividend Discount Model

A relatively new firm has the dividend payment history shown in
Table 9-10. Suppose this stock sells for $8 per share. Estimate the
shareholders' required rate of return using the dividend discount model
with the following:
a. The dividend growth rate calculated over the firm's entire history.
b. The growth rate calculated over the actual dividend paying history
only.
Why are the two answers different? Which do you think is most meaningful?
TABLE 9-10
Year Dividends Paid
2000 $0
2001 0
2002 0
2003 0
2004 0.10
2005 0.13
2006 0.15
2007 0.18

Solution Preview

I have copied and pasted my solution and uploaded it as a Microsoft Word document. I wasn't sure how the formatting would transfer so I included both. I hope you find this helpful.

Dividends over the Firm's Entire History
- First, to use the dividend discount model (DDM), several inputs are needed
- DDM formula:

Stock Value = Dividend Per Share Expected for the Next Year
Required rate of return - Dividend growth rate

Value = D / (k + g) where k is the required rate of return and g is the dividend growth rate

- The stock value is given - $8
- The dividends expected in the following year can be calculated using the dividend growth rate - next year's dividend = this year's dividends * (1 + g)
- To calculate the average growth rate over the firm's entire history, we must add up all dividends paid and divide this total by the number of years the firm has been in operation

Average growth rate = ...

Solution Summary

The question provides the dividends paid over several years and asks for computations of shareholders' required rate of return using the dividend discount model (DDM) and two different assumptions regarding the dividend growth rate.

$2.19