CIMA F2 Syllabus A. Financing capital projects - Dividend Valuation Model - Notes ^{2 / 7}

DVM can be with or without growth.

DVM (without growth)

The Cost of Equity (ke) is calculated like this:

• Dividend (D) / ex div Share Price (Po)

• Note:
  Ex div share price - means share price without a dividend
  Cum div share price - means share price with a dividend

  If the ‘ex div’ share price is provided, use this figure; or
  If the ‘cum div’ share price is provided, deduct the dividend to find the ‘ex div’ share price.

Illustration 1

Cow has just paid a dividend of 30c and its ordinary shares have an ex-div market value of $6
each. 

Required:

What is Cow’s cost of equity?

• The cost of equity is:

  ke = D / Po
  ke = 30/ 600 = 0.05 = 5%

Illustration 2

The current share price is $5.00 cum div and the company has consistently paid a dividend of 50 cents per share. 

Required:

Calculate the Cost of Equity.

• = dividend (D) / ex div share price (P)

  The ex div share price is $4.50 ($5.00 - $0.50). 

  The cost of equity is therefore 50c / 450c  = 0.111 = 11.1%.

DVM with growth

• [Dividend x (1+g) / Share Price (Without divs)] + g

Illustration

The equity shares are quoted at $4.00 cum div with a dividend of 50 cents per share just been paid.  

Assuming that the growth rate in dividends is 5% a year, the cost of equity is:

• Solution 

  (50 x 1.05) / (4.00 - 0.50) + 5 = 20%

One of the major assumptions of the dividend valuation model is that it assumes dividends grow at a constant rate in perpetuity.