Let's Get Real About the Dividend Growth Model

Abstract

The dividend growth model, sometimes called the dividend discount model or discounted cash flow model, is a commonly used tool for estimating the cost of equity capital, particularly in the context of utility rate setting and unitary appraisal. Although the assumption of constant growth in perpetuity is almost never realistic, the constant growth version of the model is still commonly used in practice. However, given modern computing technology, there is no reason not to use the general dividend growth model when estimating the cost of equity. If the constant growth assumption is appropriate in a particular case, it can simply be substituted into the general model. If constant growth is not an appropriate assumption, which will almost always be the case in practice, then the general model should be employed rather than trying to manipulate the constant growth model.