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

An analyst values a mature company with the Gordon growth model. Holding all other inputs constant, the analyst's estimate of intrinsic value would most likely increase the most if:

Intrinsic value rises most when expected dividend growth increases from 4% to 5%. In the Gordon growth model, value equals D1 divided by (r minus g), so a higher growth rate narrows the denominator and raises value, while a higher required return or lower growth reduces it.

  1. Athe required rate of return rises from 9% to 10%
  2. Bthe expected dividend growth rate falls from 4% to 3%
  3. Cthe expected dividend growth rate rises from 4% to 5%Correct

Explanation

Value = D1/(r - g). Value rises when r falls or g rises. A higher required return and a lower growth rate both widen r - g and lower value. Only the growth rate increase narrows the denominator and raises value.

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