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Question 10.EX.4.3: Calculation of share price using the dividend growth model ...

Calculation of share price using the dividend growth model

Shareholders require a 15 per cent return on their shares and a company has just paid a dividend of 80p per share. Over the past four years, the company has paid dividends of 68p, 73p, 74p and 77p per share (most recent dividend last). What is a fair price for the share using the dividend growth model?

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We need to estimate the dividend growth rate, g. Over the four-year period, dividends have grown from 68p to 80p per share and so:

68 \times(1+g)^4=80

Rearranging:

1+g=\sqrt[4]{\cfrac{80}{68}}

hence:

g=4.1 \%

Inserting D_0, g and r into the dividend growth model:

P_0=\cfrac{80(1+0.041)}{015-0.041}=\cfrac{83.28}{(015-0041)}=£ 7.64

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