Corporate Financial Reporting · Valuation of Shares (including Determination of Goodwill)

Dividend Discount Model and DCF Share Valuation

Updated 11 October 2026 · Fact-checked

These models value a share at the present value of the cash it will give its owner. The Gordon model uses P0 = D1 ÷ (ke − g) for dividends growing at a constant rate. DCF discounts forecast cash flows at a rate that matches their risk. Find the cash flows, choose the rate, discount, then add them up.

Understand Other Valuation Models (DCF, Dividend Growth)

A share is worth what its future cash is worth today. The cash can be dividends to the shareholder or free cash flows of the business. You discount each amount back at a rate that reflects its risk. The sum is the value. This is the income approach. Ind AS 113 describes it as valuation techniques that convert future amounts (such as cash flows or income and expenses) to a single current, discounted amount.

The dividend discount model (DDM) applies this to dividends. If a dividend D0 was just paid and grows forever at a constant rate g, the next dividend is D1 = D0 × (1 + g). The value today is D1 ÷ (ke − g). This is the Gordon growth model. It works only if ke is greater than g. If g is zero, the formula becomes D1 ÷ ke, the value of a constant dividend forever.

Many questions give uneven growth. For example, dividends grow fast for a few years, then settle at a stable rate. This is the two-stage model. You discount the dividends of the fast-growth years one by one. At the end of that stage, you use the Gordon formula to get a terminal price. You then discount that price back as well.

The DCF method works the same way with free cash flows. You discount the cash flows of the firm at the cost of capital to get enterprise value. Then you subtract debt to get equity value. Divide by the number of shares to get value per share. Keep the cash flows and the rate consistent. Ind AS 113 says discount rates should reflect assumptions consistent with those inherent in the cash flows. Nominal cash flows go with a nominal rate. After-tax cash flows go with an after-tax rate.

Also know the two ways to handle risk. You can discount expected cash flows at a risk-adjusted rate. Or you can adjust the cash flows to certainty-equivalents and discount them at the risk-free rate. Never adjust for the same risk twice.

Key rules to remember

Next dividend: D1 = D0 × (1 + g); D0 is the dividend just paid. If the question gives the dividend expected next year, use it directly as D1.
Gordon growth model: P0 = D1 ÷ (ke − g); Needs constant growth forever and ke > g. P0 is the value today, just after D0 is paid.
Zero growth: P0 = D ÷ ke; Special case of Gordon with g = 0.
Implied cost of equity: ke = (D1 ÷ P0) + g; Rearranged Gordon model. Use it when the market price is given.
Growth from retention: g = b × r; b is the retention ratio and r is the return on equity. It assumes r stays constant. Use only when the question gives these inputs.
Two-stage value: P0 = Σ Dt ÷ (1 + ke)^t for the fast-growth years + [Dn+1 ÷ (ke − g)] ÷ (1 + ke)^n; n is the last year of the fast-growth stage. g is the stable growth rate after that.
Present value of a cash flow: PV = CF ÷ (1 + r)^t; Used for every year in a DCF.
Equity value from DCF: Equity value = Enterprise value − Debt (net of cash if stated); Divide by the number of equity shares to get value per share.

How to solve Other Valuation Models (DCF, Dividend Growth) questions

Use this order for any dividend model or DCF question.

1Read what is given: last dividend or next dividend, growth rate, cost of equity, forecast period, and market price if any.
2Decide whether D0 or D1 is given. If D0, compute D1 = D0 × (1 + g).
3Check the growth pattern. Constant forever means the Gordon model. Fast growth then stable growth means the two-stage model.
4Check that ke is greater than g in every stage where you use the Gordon formula.
5For a two-stage case, list the dividends of each fast-growth year and discount each one. Then find the terminal value at the end of that stage and discount it back.
6For a DCF case, discount the free cash flows at the cost of capital, add the terminal value, then subtract debt to get equity value.
7Divide by the number of shares if value per share is asked.
8State the value, compare it with the market price if given, and write a one-line conclusion.

Quickest way: Gordon shortcut with a growth check

When to use it: Use it when dividends grow at one constant rate and the question asks for the value or the implied rate.

Write D1 first. Never put D0 into the formula by habit.
Compute ke − g and check it is positive.
Divide D1 by that gap to get P0.
If the price is given and ke is asked, use ke = D1 ÷ P0 + g.
For the two-stage case, build a small table of year, dividend, discount factor and present value. Add the terminal value as the last row.

Common mistakes in Other Valuation Models (DCF, Dividend Growth)

Using D0 instead of D1 in the Gordon formula.
The question gives the dividend just paid and students plug it in directly.
Fix: Read the wording. 'Just paid' or 'last year' means D0, so multiply by (1 + g).
Applying the Gordon model when g is greater than or equal to ke.
Students skip the check and get a negative or meaningless value.
Fix: Check ke − g first. If the check fails, the constant-growth model cannot be used for that stage.
Forgetting to discount the terminal value back to today.
The Gordon formula gives a number that looks like the final answer.
Fix: The terminal value is a price at the end of year n. Divide it by (1 + ke)^n.
Using the wrong year for the terminal dividend.
Students use the last fast-growth dividend instead of the first stable-growth one.
Fix: Terminal value at year n = Dn+1 ÷ (ke − g), where Dn+1 is the first dividend at the stable growth rate.
Subtracting debt from equity cash flows, or not subtracting it from firm cash flows.
Students mix up enterprise value and equity value.
Fix: Cash flows to the firm discounted at the cost of capital give enterprise value, so subtract debt. Dividends discounted at ke give equity value directly.
Mixing rates and cash flows, such as pre-tax flows with an after-tax rate.
The rate is given in the question and students use it without checking.
Fix: Match nominal with nominal and after-tax with after-tax, as Ind AS 113 requires of discount rates.

Worked examples

Example 1

Shreya Ltd has just paid a dividend of ₹6 per share. Dividends are expected to grow at 5% a year forever. The required return of equity shareholders is 15%. Find the value per share today.

Show the solution

D0 = ₹6 and g = 5%, so D1 = 6 × 1.05 = ₹6.30.
ke − g = 15% − 5% = 10%, which is positive, so the Gordon model applies.
P0 = 6.30 ÷ 0.10 = ₹63.

Answer: The value per share is ₹63.

Example 2

Kaveri Ltd paid a dividend of ₹4 per share this year. Dividends will grow at 10% for the next two years, then at 5% forever. The cost of equity is 15%. Find the value per share.

Show the solution

D1 = 4 × 1.10 = ₹4.40.
D2 = 4.40 × 1.10 = ₹4.84.
D3 = 4.84 × 1.05 = ₹5.082. This is the first dividend at the stable rate.
Terminal value at the end of year 2 = 5.082 ÷ (0.15 − 0.05) = ₹50.82.
PV of D1 = 4.40 ÷ 1.15 = ₹3.826.
PV of D2 = 4.84 ÷ 1.3225 = ₹3.660.
PV of terminal value = 50.82 ÷ 1.3225 = ₹38.427.
Total = 3.826 + 3.660 + 38.427 = ₹45.913.

Answer: The value per share is about ₹45.91.

Exam tips

In MCQs, the usual trap is D0 against D1. Check which one is given before you calculate.
In written answers, show a table of year, cash flow, discount factor and present value. Marks are given for method even if the arithmetic slips.
Always state the assumptions: constant growth, ke greater than g, and the date of valuation.
If the market price is given, compare it with your value and say whether the share looks overvalued or undervalued.
Keep three decimals in discount factors and round only the final answer.

Practice questions from Valuation of Shares (including Determination of Goodwill)

Other Valuation Models (DCF, Dividend Growth) in other exams

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

Other Valuation Models (DCF, Dividend Growth): frequently asked questions

What is the Gordon growth model?

It values a share as P0 = D1 ÷ (ke − g). It assumes dividends grow at a constant rate forever and that ke is greater than g. It is the simplest dividend discount model.

How is DCF different from the dividend discount model?

The DDM discounts dividends paid to shareholders. DCF usually discounts free cash flows of the business at the cost of capital. You then subtract debt to reach equity value.

Can I use the Gordon model if growth is not constant?

Not for the whole life. Use a two-stage model. Discount the uneven dividends one by one, then use the Gordon formula for the stable stage and discount that terminal value back.

How do I get the growth rate if it is not given?

If the question gives the retention ratio and the return on equity, use g = b × r. This assumes the return on new investment stays the same. Otherwise, use the growth rate stated in the question.