Solution

Solution:
i. Establishment of estimated growth rate in earnings and dividends.
XYZ Company’s current EPS is $4.75. It was $3.90 a year ago. The company pays out 35% of its earnings as dividends, and the stock sells for $45.
a. Calculate the past growth rate in earnings.
b. Calculate the next expected dividend. Assume that the past growth rate will continue
Answer:
If payout ratio is constant, then dividend growth rate will be same as earnings growth rate.

a) dividend growth rate over the last year = (4.75/3.90) - 1 = 0.2179 or 21.79%

b) expected dividend D1 = D0*(1+g) = 4.75*(1+0.2179) = 5.78

ii. Dividend Growth Model
Dividend growth model is a valuation method which takes into consideration dividend per share and its expected growth. This model assumes that dividends grow at a constant rate in perpetuity. Thus, it is usually employed during the valuation of companies belonging to for mature and stable industries, having steady dividend growth.
The formula is given by:
Intrinsic Value= Current Dividend* (1+Dividend Growth)/(Required Return-Dividend Growth)

How to Calculate Growth Rate in Dividends
Instructions
1.
Determine the dividends per share from the beginning of the period examined and the dividends per share from the end of the period. For example, an investor wants to know a firm's dividend growth rate from Year 1 to Year 3. In Year 1, the firm paid dividends of $1.25 per share. In Year 3, the firm paid dividends of $1.68 per share.
2
Subtract the latest dividends per share from the older dividends per share. In our example, $1.68 minus $1.25 equals $0.43. This is the change in dividends.
3
Divide the change in dividends by the older dividends per share to calculate the dividend growth rate. In our example, $0.43 divided by $1.25 equals 34.4 percent