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Gordon Growth Model:
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The Gordon Growth Model (also known as the Dividend Discount Model) is used to calculate the cost of equity by considering the expected dividend payments, current stock price, and the constant growth rate of dividends.
The calculator uses the Gordon Growth Model equation:
Where:
Explanation: The model assumes dividends will continue to grow at a constant rate indefinitely, and the cost of equity is the sum of the dividend yield and the growth rate.
Details: The cost of equity is a crucial component in corporate finance, used for capital budgeting decisions, valuation of companies, and determining the weighted average cost of capital (WACC).
Tips: Enter the expected dividend in dollars, current stock price in dollars, and growth rate as a percentage. All values must be positive numbers.
Q1: What are the limitations of the Gordon Growth Model?
A: The model assumes a constant growth rate forever, which may not be realistic for many companies. It also doesn't work for companies that don't pay dividends.
Q2: What is a typical cost of equity range?
A: For most stable companies, cost of equity typically ranges between 8% to 15%, but can vary significantly depending on risk and market conditions.
Q3: How do I estimate the growth rate (g)?
A: The growth rate can be estimated using historical dividend growth, analysts' forecasts, or the company's sustainable growth rate (ROE × retention ratio).
Q4: Can this model be used for non-dividend paying stocks?
A: No, alternative models like the Capital Asset Pricing Model (CAPM) would be more appropriate for non-dividend paying stocks.
Q5: How sensitive is the result to input changes?
A: The model is particularly sensitive to the growth rate assumption, as small changes in g can significantly impact the calculated cost of equity.