CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models

Gordon Growth Model Formula for CFA Level I

Updated 7 October 2026 · Fact-checked

The Gordon growth model values a stock whose dividends grow at a constant rate forever. Value today = next year's dividend ÷ (required return − growth rate). To solve, find D1, confirm r is greater than g, and divide. You can also rearrange it to get the implied growth rate or required return.

Understand Gordon Growth Model

A share is worth the present value of the dividends you expect to receive. If dividends last forever, you would have to add up an endless series of discounted payments. The Gordon growth model (constant-growth dividend discount model) makes this simple by assuming dividends grow at the same rate, g, every year, forever.

With that assumption the endless series collapses into one fraction. The value today, V0, equals the next dividend, D1, divided by the gap between the required return, r, and the growth rate, g. It is a growing perpetuity. A plain perpetuity pays a fixed cash flow. This one pays a cash flow that grows.

The gap r − g drives the answer. A small gap gives a very large value. If g is close to r, value explodes. If g = r, the value is undefined because you divide by zero. If g is greater than r, the value is negative and meaningless. So the model needs r > g.

The model works best for mature, stable, dividend-paying companies, such as a utility with steady payouts. It is a poor fit for young firms, firms that pay no dividends, or firms whose growth is uneven. For those, you use multistage models. Small changes in r or g change value a lot, so treat the output as an estimate, not a precise figure.

You can rearrange the formula. Required return r = D1 ÷ V0 + g: the dividend yield plus the growth rate. Implied growth g = r − D1 ÷ V0, when you know the market price and treat it as value. The model also gives a justified P/E and P/B, which link to other valuation topics.

Key formulas to remember

Gordon growth value: V0 = D1 ÷ (r − g); Requires r > g. D1 is the dividend expected one year from now, not the dividend just paid.
Next dividend from last dividend: D1 = D0 × (1 + g); Use this when the question gives the most recent dividend D0.
Required return: r = D1 ÷ V0 + g; Dividend yield (on D1) plus growth rate.
Implied growth rate: g = r − D1 ÷ V0; If D0 is given, you can also write g = (V0 × r − D0) ÷ (V0 + D0). This comes from V0 = D0 × (1 + g) ÷ (r − g).
Value at a future time t: Vt = Dt+1 ÷ (r − g); Used as a terminal value in multistage models. Under constant growth, Vt = V0 × (1 + g)^t.

How to solve Gordon Growth Model questions

Use this order for any Gordon growth question, whether it asks for value, required return or growth.

1Identify what is unknown: V0, r or g.
2Check whether the given dividend is D0 (just paid) or D1 (expected next). Wording like 'just paid' or 'most recent' means D0.
3If you have D0, compute D1 = D0 × (1 + g).
4Write the formula V0 = D1 ÷ (r − g) and rearrange for the unknown.
5Convert percentages to decimals and compute r − g first.
6Check that r > g and that the answer is sensible, such as a positive value.
7Match your answer to the closest of the three options, listed smallest to largest.

Quickest way: Yield-plus-growth shortcut

When to use it: Use when the question gives a price and a dividend and asks for required return or implied growth.

Compute the forward dividend yield: D1 ÷ price.
For required return, add g to that yield.
For implied growth, subtract that yield from r.
On the calculator, if you have D0 = 2, g = 4% and price = 50, key 2 × 1.04 ÷ 50 = on the BA II Plus. On the HP 12C (RPN) key 2 ENTER 1.04 × 50 ÷. The stack gives 2.08 after the multiplication and 0.0416 after the division. The result, 0.0416, is the forward dividend yield, not r or g.
Then finish: add g (0.04) to get r = 0.0816. Separately, as a different illustration, if a question gave r = 0.08 with the same D1 and price, you would subtract the yield from r: g = 0.08 − 0.0416 = 0.0384. Do not mix the r = 0.08 illustration with the r = 0.0816 result above.

Common mistakes in Gordon Growth Model

Using D0 in the numerator instead of D1.
The question gives the dividend just paid and you plug it straight in.
Fix: Always ask whether the dividend is next year's. If it was just paid, multiply by (1 + g) first.
Applying the model when g ≥ r.
You calculate mechanically without checking the inputs.
Fix: Check r > g first. If not, the constant-growth model is not valid for that company.
Subtracting in the wrong order, g − r.
Rushing under time pressure.
Fix: The denominator is always required return minus growth. It must be positive.
Forgetting to convert percentages to decimals.
Mixing 8% and 0.08 in one calculation.
Fix: Write 0.08 and 0.03 before subtracting. The denominator is then 0.05.
Using the model for a firm with no dividends or irregular growth.
Treating it as a universal valuation tool.
Fix: Use it only for stable, dividend-paying firms with growth you can expect to continue. Otherwise consider multistage or free cash flow models.

Worked examples

Example 1

A company just paid an annual dividend of €2.00 per share. Dividends are expected to grow at 4% forever. The required return is 9%. What is the intrinsic value per share? A. €40.00 B. €41.60 C. €52.00

Show the solution

The €2.00 is D0, the dividend just paid.
D1 = 2.00 × 1.04 = €2.08.
r − g = 0.09 − 0.04 = 0.05.
V0 = 2.08 ÷ 0.05 = €41.60.

Answer: B. €41.60. Option A (€40.00) is the trap of using D0 instead of D1: 2.00 ÷ 0.05 = €40.00. Option C (€52.00) comes from dividing D1 by g alone instead of by r − g: 2.08 ÷ 0.04 = €52.00. The correct value is €41.60.

Example 2

A stock trades at $50. The next dividend, D1, is expected to be $2.00. The required return is 8%. Assuming the Gordon growth model holds and the price equals intrinsic value, what is the implied growth rate? A. 3.0% B. 4.0% C. 6.0%

Show the solution

Use g = r − D1 ÷ V0.
D1 ÷ V0 = 2.00 ÷ 50 = 0.04.
g = 0.08 − 0.04 = 0.04, or 4.0%.
Check: 2.00 ÷ (0.08 − 0.04) = 2.00 ÷ 0.04 = $50. Correct.

Answer: B. 4.0%. The dividend yield is 4%, so growth must be the other 4% of the 8% required return.

Exam tips

Read the wording for D0 versus D1. Examiners often give D0 on purpose.
Eliminate options quickly by checking the denominator: a small r − g should give a large value, so a very low value is likely wrong.
Questions on limitations often ask when the model is unsuitable: no dividends, very high growth, or growth above the required return.
There is no penalty for wrong answers, so always pick an option, but compute r − g first to cut it to one choice.
Know how value changes: higher g or lower r raises V0, and the effect is large when r − g is small.

Practice questions from Discounted Cash Flow (DCF) and Growth Models

Gordon Growth Model in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Gordon Growth Model: frequently asked questions

What is the Gordon growth model formula?

V0 = D1 ÷ (r − g), where D1 is the dividend expected next year, r is the required return and g is the constant growth rate. It requires r to be greater than g. It is the constant-growth form of the dividend discount model.

What are the assumptions of the Gordon growth model?

Dividends grow at a constant rate forever, and the required return is constant and higher than that growth rate. The firm is assumed to be stable and mature. These assumptions are why the model suits steady dividend payers but not high-growth firms.

How do I find the implied growth rate?

Rearrange the formula: g = r − D1 ÷ V0. Use the market price as V0 if you assume it equals intrinsic value. If you only have D0, use g = (V0 × r − D0) ÷ (V0 + D0), which comes from V0 = D0 × (1 + g) ÷ (r − g).

What are the main limitations of the model?

It is very sensitive to small changes in r and g. It fails when g is greater than or equal to r, and it does not fit firms with no dividends or uneven growth. In those cases, multistage or free cash flow models are better.