CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
A company is expected to pay a dividend of $2.40 per share next year. Dividends are expected to grow at a constant 4% per year indefinitely, and the required rate of return on the stock is 10%. Using the Gordon growth model, the intrinsic value per share is closest to:
The intrinsic value is $40.00 per share. The Gordon growth model divides the next-year dividend of $2.40 by the difference between the required return of 10% and the growth rate of 4%, which is 6%. Growing the dividend again would wrongly give $41.60.
- A$24.00
- B$40.00Correct
- C$41.60
Explanation
The Gordon growth model gives V0 = D1/(r - g). Here D1 is already the next-year dividend, so V0 = 2.40/(0.10 - 0.04) = 2.40/0.06 = $40.00. Choosing $41.60 results from growing D1 by 4% again, which double counts growth, while $24.00 divides by r only.
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