The Dividend Growth Model

The dividends at date 1 are 0.40 X $10 = $4 per share. The retention ratio is 0.60 (1 — 0.40), implying a growth rate in dividends of 0.12 (0.60 X 0.20).

From the dividend-growth model, the price of a share of stock is

Using the NPVGO model, it is more difficult to value a firm with growth opportunities each year (like Cumberland) than a firm with growth opportunities in only one year (like Sarro). In order to value according to the NPVGO model, we need to calculate on a per-share basis (1) the net present value of a single growth opportunity, (2) the net present value of all growth opportunities, and (3) the stock price if the firm acts as a cash cow, that is, the value of the firm without these growth opportunities. The value of the firm is the sum of (2) + (3).

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