# What is a dividend growth model? (with photo)

The dividend growth model is a method for estimating a company’s cost of capital.

The dividend growth model is a method for estimating a company’s cost of capital. The cost of equity is closely related to the company’s required rate of return, which is the percentage of return that a company must earn on business opportunities. Companies use this model to perform a stock valuation related to the dividends and growth of their stock, which is discounted back to today’s dollar value. This allows business owners and managers to use some basic assumptions to estimate at what stock price a company will earn the required rate of return.

The basic assumptions in the dividend growth model assume that the value of a stock is derived from the company’s current dividend, historical dividend growth percentage, and required rate of return for business investments. Business owners and managers can determine their own rate of return or use a standard rate from the business environment. Standard rates of return can be the historical percentage of return on a national stock exchange or the rate of return a company can earn by investing in other business opportunities.

The dividend growth model is often calculated using the following formula: value equals [dividendo atual vezes (um mais a porcentagem de crescimento do dividendo)] divided by the required rate of return minus the dividend growth rate percentage. For example, suppose a company pays a dividend of \$1.50 US dollars (USD), has a historical growth rate of 2 percent per year, and a company requires a rate of return of 12 percent. Using this formula, the value of shares to obtain a required rate of return is \$15.30 USD: (1.50 x (1 + 0.02)) / (0.12 + 0.02). If a company wants to earn its 12% rate of return under these conditions, it must buy shares when they reach \$15.30 on the open market.