Saturday, April 3, 2010


The Dividend Growth Model: Zero Growth

In addition to its use in constant and variable growth situations, the dividend valuation model can also be used to estimate the cost of equity of no growth companies. The cost of equity of a share on which a constant amount of dividend is expected perpetually is given as follows:

Ke = DIV1 / Po

The growth rate will be zero if the firm does not return any of its earnings; that is, the firm follows a policy of 100% payout. Under such case, dividends will be equal to earnings, and therefore above equation can also write as:

Ke = DIV 1 / Po = EPS1 / Po

Which implies that in a no-growth situation, the expected earnings price (E/P) ratio may be used as the measure of the firm’s cost of equity.

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