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

A company just paid an annual dividend of $2.00 per share. Dividends are expected to grow at 5% per year indefinitely, and the required return on equity is 9%. The value of a share using the Gordon growth model is closest to:

The value is about $52.50. The next dividend is $2.00 × 1.05 = $2.10, and dividing by the difference between the required return and growth, 9% − 5% = 4%, gives $52.50. Using the current dividend would understate value.

  1. A$22.22
  2. B$50.00
  3. C$52.50Correct

Explanation

D1 = 2.00 × 1.05 = 2.10. Value = 2.10 / (0.09 − 0.05) = 52.50. Using D0 instead of D1 gives 2.00/0.04 = 50.00, which is wrong. Dividing 2.00 by 0.09 gives 22.22, ignoring growth.

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