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CMA Final · Strategic Performance Management and Business Valuation · Business Valuation Methods and Approaches

Under the Gordon growth (constant growth) form of the dividend discount model, the intrinsic value of a share today is computed as:

Value is next year's expected dividend divided by the difference between the cost of equity and the constant growth rate. The numerator must be D1, the first dividend to be received, and the denominator subtracts growth from the required return.

  1. ACurrent dividend D0 divided by (ke − g)
  2. BNext year's expected dividend D1 divided by (ke − g)Correct
  3. CNext year's expected dividend D1 divided by (ke + g)
  4. DCurrent earnings per share multiplied by (1 + g) divided by ke

Explanation

The Gordon model values a share as P0 = D1/(ke − g), valid when ke exceeds g. Using D0 without growing it understates value because the first cash flow expected is D1. Adding g to ke in the denominator is a sign error.

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