## Valuation Using Dividend Growth Model

Dividend growth model is a model that is used to determine the value of a stock. If a stock pays dividends,the total amount of the present value of all the future cash flows/dividends is the value of the stock.

To compute the the price of the common stock using the dividend growth model we use the formula below;-

{eq}P_o = D1/(1+r)^1 + D2/(1+r)^2 +D3/(1+r)^3...........+Dn/(1+r)^n + Dn(1+g)/(r-g)/(1+r)^n {/eq}

Where;-

• D1,D2,D3,D4.....Dn are dividends issued at different periods
• Po -The price of the common stock
• r- Required rate of return
• g -growth rate

Given;-

• D1 = 1
• g = 20% for year 2
• D2 = 1(1+0.2) = 1.2

Terminal value given a constant growth of 10%

{eq}*Terminal\ value = D3 / (Ke - g) {/eq}

{eq}*Terminal\ value = 12(1+0.1) / (0.15-0.1) = 26.4 {/eq}

Computing the value at time t= 0 we get....

{eq}*P_o = 1/(1+0.15)^1 + (1.2+26.4)/(1+0.15)^2 = 21.74 {/eq}

The value of the stock at time t=0 is \$21.74