Wize University Introduction to Finance Textbook > Equity Valuation

Common Shares (No Growth)

Zero-Growth Dividend Model

• Generalized model of discounting future dividends.

• Suitable for stable/mature companies and for preferred shares valuation

• Assumes no growth in dividend payments

• Assumes company lives on forever

Image illustrating Dividend Discount Model (Zero Growth)

Formula breakdown:

D = Constant dividend

r = Risk-adjusted effective periodic discount rate (expected return)

Example: Dividend Discount Model (Zero Growth)

DT Bank pays a $4 dividend to its preferred shareholders. If the required rate of return on this stock is 8%, what is the price today?

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Practice: Dividend Discount Model (Zero Growth)

Royal Bank of Saudi Arabia’s perpetual preferred stock pays annual dividends of $1.3750 and was originally issued to be priced to yield at 5.5%.

What was the price of the preferred stock at issuance?

If your required rate of return is 8%, what is the reasonable price of the perpetual preferred stock from your perspective?

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Extra Practice

XYZ Inc is expecting to pay a dividend of $1.50 next year, $2.00 the year after, and $2.50 the year after that. Investors also expect the price of the stock to be $80 in 3 years. If the required rate of return is 8%, what is the value of the stock today?

LOYC Corp just paid a dividend of $2.50 to common shareholders. The company does not expect to change the amount of the dividend for the foreseeable future. If the risk premium on the company's stock is 4% and t-bills are yielding 3%, what is the value of the company's stock today?

Common Shares (No Growth)

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Zero-Growth Dividend Model

Formula breakdown:

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Example: Dividend Discount Model (Zero Growth)

Practice: Dividend Discount Model (Zero Growth)

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Extra Practice