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

Holding all else constant, which change would most likely decrease the intrinsic value of a share estimated with the Gordon growth model?

A higher required return on equity would most likely decrease the value. In the Gordon growth model the denominator is the required return minus the growth rate, so increasing the required return enlarges the denominator and reduces the estimated share value.

  1. AA lower required return on equity
  2. BA higher expected dividend growth rate
  3. CA higher required return on equityCorrect

Explanation

Value equals D1/(r - g). Raising r widens the denominator and lowers value. A lower r or higher g narrows the denominator and raises value.

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