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Up0
I do not understand how we arrive to the formula. Why do we divide the numerator by E1 only and leave the denominator r-g unchanged. Do you have the demonstration of the formula for me? Many thanks for your help and time.
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Up5
We divide both sides of the formula by E1, rather than numerator and denominator, to my understanding.
P0 = D1 / (r – g)
P0/E1 = (D1/E1) / (r – g)Where
- P0 = price/value at period 0
- E1 = earnings at period 1
- r = required return
- g = dividend growth rate
We leave (r – g) alone because we want to ‘create’ D1/E1, which is the dividend payout ratio, which is (1 – b):
P0/E1 = (D1/E1) / (r – g)
P0/E1 = (1 – b) / (r – g)
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