CFA CFA Level 1 Dividend Discount Model Example: Why not Gordon Growth Model?

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Dividend Discount Model Example: Why not Gordon Growth Model?

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  • This topic has 2 replies, 3 voices, and was last updated Jul-249:39 am by pcunniff.
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    • Avatar of Zee TanZee Tan
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        The Gordon Growth Model is used to determine stock price as the present value of all future dividend payments:

        P=D1(rg)

        where:

        • P = Current stock price
        • g = Constant growth rate expected for dividends, in perpetuity
        • r = Constant cost of equity capital for the company (or rate of return)
        • D1 ​= Value of next year’s dividends​

        The question has already given you the stock price one year from now, so Gordon Growth Model is not necessary. Instead you calculate the current value of the stock price by discounting it to today.

        First you calculate the dividend payment 1 year from today, D1:

        • = D0 * growth rate
        • = $6.10 * 1.04
        • = $6.34

        So one year from today, you will have a dividend payment of $6.34 and a stock worth $60:

        • $6.34 + $60 = $66.34

        Discounting it to today:

        • = $66.34 / (risk-free rate + equity premium)
        • = $66.34 / (1.15)
        • = $57.70

        The answer explanation assumes that the expected stock price that they quote ($60) is AFTER another dividend payment, which is not explicitly said in the question.

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