1. What is the Gordon Growth Model?

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. It assumes dividends will continue to grow at a constant rate indefinitely.

2. How Does the Calculator Work?

The calculator uses the Gordon Growth Model:

Where:

• \( D_1 \) — Expected dividend per share next period ($)
• \( P_0 \) — Current stock price ($)
• \( g \) — Constant growth rate of dividends (%)
• \( K_e \) — Cost of equity (%)

Explanation: The model calculates the required rate of return that investors demand for investing in a company's equity, based on expected dividend payments and growth prospects.

3. Importance of Cost of Equity Calculation

Details: Cost of equity is a critical component in capital budgeting decisions, company valuation, and determining the weighted average cost of capital (WACC). It helps investors assess the risk-return profile of an investment.

4. Using the Calculator

Tips: Enter expected dividend in dollars, current stock price in dollars, and growth rate as a percentage. All values must be valid (dividend > 0, price > 0, growth rate ≥ 0).

5. Frequently Asked Questions (FAQ)

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 requires that the growth rate is less than the cost of equity.

Q2: How do I determine the expected dividend (D1)?
A: D1 is typically based on the company's dividend history, payout policy, and future earnings projections. Analysts often use the most recent dividend and apply the expected growth rate.

Q3: What is a reasonable growth rate (g)?
A: The growth rate should be sustainable long-term and typically aligns with the company's earnings growth rate. It's often estimated based on historical growth, industry averages, or analyst projections.

Q4: Can this model be used for companies that don't pay dividends?
A: No, the Gordon Growth Model requires dividend payments. For non-dividend paying companies, alternative models like the Capital Asset Pricing Model (CAPM) are more appropriate.

Q5: How does this compare to other cost of equity models?
A: While simple and intuitive, the Gordon Model is less comprehensive than CAPM, which considers market risk factors. However, it's particularly useful for stable, dividend-paying companies.