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Financial Management · Models for the valuation of shares

Dividend Valuation Model and Dividend Growth for ACCA FM

Updated 11 October 2026

The dividend valuation model values a share as the present value of all its future dividends. With constant growth g and cost of equity Ke, the ex div price is P0 = D0(1 + g) ÷ (Ke − g). With no growth, P0 = D ÷ Ke. Gordon's model estimates growth as g = b × r.

Understand Dividend Valuation Model and Dividend Growth

A share gives its owner a stream of future dividends. Its value today is what those dividends are worth after discounting at the shareholders' required return. That return is the cost of equity, Ke.

If the dividend is the same every year forever, the share is a perpetuity. Its value is the dividend divided by Ke. If dividends grow at a constant rate g forever, the sum of the discounted dividends gives a neat formula: next year's dividend divided by (Ke − g).

The formula only works when Ke is greater than g. It gives an ex div value. That means the dividend about to be paid is not included. A cum div price still includes the dividend that is about to be paid, so you deduct that dividend to get the ex div price.

You also need a growth rate. You can get it from history, or from Gordon's growth approximation: g = b × r. Here b is the proportion of earnings retained and r is the return earned on retained funds. The model rearranges to give Ke = D1 ÷ P0 + g, which is how the cost of equity is usually found in FM.

The model assumes constant growth forever, a known and steady Ke, and that dividends are the only source of value. It is sensitive to small changes in g, and it suits mature, stable companies better than start-ups.

Key rules to remember

Constant dividend (no growth)
P0 = D ÷ Ke
Ex div value. Ke = D ÷ P0.
Constant growth model
P0 = D0 × (1 + g) ÷ (Ke − g) = D1 ÷ (Ke − g)
Ex div value. D0 is the dividend just paid. Needs Ke > g.
Cost of equity from the model
Ke = D1 ÷ P0 + g = D0(1 + g) ÷ P0 + g
Use the ex div price.
Historic growth rate
g = (latest dividend ÷ earliest dividend)^(1 ÷ n) − 1
n is the number of growth periods, not the number of dividends.
Gordon's growth approximation
g = b × r
b = proportion of earnings retained; r = return on reinvested funds, often ROCE or return on equity.
Cum div to ex div
Ex div price = cum div price − dividend about to be paid
Do this before applying the formula.

How to solve Dividend Valuation Model and Dividend Growth questions

Use this order for any dividend valuation question.

  1. 1Identify what you must find: share value, Ke or g.
  2. 2Find the latest dividend D0 and check whether the share price is cum div or ex div. If cum div, deduct the dividend about to be paid.
  3. 3Decide the dividend pattern: constant, constant growth or growth estimated from data.
  4. 4Work out g. Use the geometric formula for historic dividends, or b × r for Gordon's model.
  5. 5Calculate D1 = D0 × (1 + g). Do not forget this step.
  6. 6Apply the formula: P0 = D1 ÷ (Ke − g), or Ke = D1 ÷ P0 + g.
  7. 7Check the result is sensible: Ke must exceed g, and the answer should be close to any given market price.
  8. 8For written parts, state the assumptions and limitations.

Quickest way: Three-line shortcut

When to use it: Section A and OT case questions where you need one number fast.

  1. Write D1 first: D0 × (1 + g).
  2. Then write the formula you need: P0 = D1 ÷ (Ke − g) or Ke = D1 ÷ P0 + g.
  3. Convert percentages to decimals once, calculate, then sanity-check that Ke > g and the price is ex div.

Common mistakes in Dividend Valuation Model and Dividend Growth

  • Using D0 instead of D1 in the numerator.

    The dividend given in the question is the one just paid, so it looks like the one to use.

    Fix: Always multiply D0 by (1 + g) unless the question gives next year's dividend.

  • Using a cum div price without adjustment.

    Students ignore the wording 'about to pay' or 'cum div'.

    Fix: Deduct the imminent dividend first to get the ex div price.

  • Counting the wrong number of years when finding historic growth.

    Students count dividends rather than gaps between them.

    Fix: Five dividends over five years means four growth periods. Use n = 4.

  • Using an arithmetic average growth rate.

    It feels simpler than a root.

    Fix: Use the geometric formula, which reflects compounding.

  • Mixing up b and the payout ratio in Gordon's model.

    Both are percentages of earnings.

    Fix: b is the retained proportion: b = 1 − payout ratio.

Worked examples

Example 1

Quartz Ltd has just paid a dividend of $0.40 per share. Dividends have grown at 5% a year and will continue to do so. Shareholders require a return of 12%. Estimate the ex div share price.

Show the solution
  1. D0 = $0.40, g = 5%, Ke = 12%.
  2. D1 = 0.40 × 1.05 = $0.42.
  3. P0 = 0.42 ÷ (0.12 − 0.05) = 0.42 ÷ 0.07.
  4. P0 = $6.00.

Answer: The ex div share price is $6.00.

Example 2

Delta Co's dividends were $0.50 four years ago and have grown to $0.61, the dividend that is about to be paid. The share price is $5.20 cum div. Estimate the cost of equity using the historic growth rate.

Show the solution
  1. Growth periods n = 4. g = (0.61 ÷ 0.50)^(1/4) − 1 = 1.22^0.25 − 1.
  2. 1.22^0.5 = 1.1045, and 1.1045^0.5 = 1.0510, so g ≈ 5.1%.
  3. Ex div price = 5.20 − 0.61 = $4.59.
  4. The $0.61 dividend is the latest dividend, D0. It is about to be paid, so it is already in the cum div price and is removed in the ex div price. The next dividend is D1 = 0.61 × 1.051 = $0.641.
  5. Ke = 0.641 ÷ 4.59 + 0.051 = 0.1397 + 0.051 = 0.1907.

Answer: The cost of equity is about 19.1%.

Exam tips

  • Check cum div or ex div before anything else. Examiners build this trap into OT questions.
  • Show D1 and the formula in written answers. Method marks are available in Section C even if your arithmetic slips.
  • Know the limitations: constant growth forever, a stable Ke, sensitivity to g, and that it ignores non-dividend value. These come up often in written parts.
  • Gordon's model needs a sensible r. If the question gives ROCE, use it only if the retained funds earn that rate.

Practice questions from Models for the valuation of shares

Dividend Valuation Model and Dividend Growth: frequently asked questions

How do I calculate the dividend growth rate in ACCA FM?

Use g = (latest dividend ÷ earliest dividend)^(1 ÷ n) − 1, where n is the number of years between them. Alternatively, use Gordon's model, g = b × r, if you are given retention and return data.

What is the difference between ex div and cum div?

A cum div price includes the right to the dividend about to be paid. An ex div price does not. The model gives an ex div value, so deduct the imminent dividend from a cum div price first.

What is Gordon's growth approximation?

It estimates future dividend growth as the proportion of earnings retained multiplied by the return earned on those retained funds: g = b × r. It assumes the return and retention stay constant.

What are the main limitations of the dividend valuation model?

It assumes dividends grow at a constant rate forever and that Ke is constant. Values are very sensitive to small changes in g and Ke. It also fits poorly for companies that pay no dividends or have uneven growth.