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

An analyst values a mature, profitable utility that pays a stable dividend with a payout ratio of 80% and expects dividends to grow at a constant rate indefinitely. Which model is most appropriate for valuing the utility's equity?

The Gordon growth model is most appropriate. The utility is mature, pays a stable dividend with a high payout ratio, and is expected to grow at a constant rate, which is exactly the situation the constant growth dividend discount model assumes.

  1. AGordon growth modelCorrect
  2. BThree-stage dividend discount model
  3. CResidual income model with negative earnings

Explanation

A stable, mature dividend payer with predictable constant growth fits the Gordon (constant growth) dividend discount model. A multistage model is needed only when growth changes over time, and a model suited to firms with negative earnings is irrelevant here.

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