Describe compare and contrast the following dividend valuati

Describe, compare, and contrast the following dividend valuation models: (1) constant-growth (2) Non-constant growth What is the relationship between dividend yield, capital gains yield & total expected return? Explain.

Solution

A constant dividend growth model assumes that the dividend given out by the firm would grow perpetually at a constant growth rate g. Using this model, the price of a stock P is predicted as:

P = D0*(1+g)/(R-g)

Where P = Price of stock

g = growth of dividend

R = Discount rate

D0 = Dividend given in time 0

In a non-constant dividend growth model, the price of the stock is calculated based on different time periods between which the growth rate changes. So if the dividend growth is g1 in time period 1 and growth is g2 in time 2 and so forth, then the Price of the stock as per Non-constant dividend growth model is:

P = D0*(1+g1)/(1+ R) + D0*(1+g1)*(1+g2)/(1+R)^2+….

The dividend yield of a stock is the dividend paid by the stock divided by the price of the stock.

So Dividend Yield = Dividend Paid/Price of Stock

The Capital Gains Yield = [Price of Stock (in Period Sold) - Price of Stock (in Period Bought)]/ Price of Stock (in Period Bought)

The total expected return is the addition of the dividend yield of the stock and the capital gains yield.