help@edupristine.com www.edupristine.com Pristine CFA Institute, CFA, and Chartered Financial Analyst are trademarks owned by CFA Institute. CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by Pristine. In Xcel CFA Series you learn important CFA concept by solving a problem in MS Excel. To download more of Xcel CFA Series spreadhseets please visit our website. Xcel CFA Series Equity Investments Reading 52 Gordon Growth Model Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate. From this sheet you will learn how to use gordon growth model to calculte the intrinsic value of stock. You should know the conditions required for the model to work and expect at least one exam question on the same concept. In Xcel CFA Series you learn important CFA concept by solving a problem in MS Excel. To download more of Xcel CFA Series spreadhseets please visit our website. Xcel CFA Series Equity Investments Reading 52 Gordon Growth Model Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate. From this sheet you will learn how to use gordon growth model to calculte the intrinsic value of stock. You should know the conditions required for the model to work and expect at least one exam question on the same concept. Question Options Stock Value Increase in Value Due to Dividend Growth A $110 $75 B $107 $75 C $107 $70 Stock XYZ paid a dividend of $3 for financial year 2011 and its investors require a rate of return of 10% on equity. The dividends are expeted to grow at a constant rate of 7% in perpetuity. Calculate the value of XYZ's stock as well as how much stoch value is due to dividend growth. Solution Gordon Growth Model Valuation Dividend 3 Expected Growth Rate in Dividend 7% Required Return on Equity (K e ) 10% FY 2012 Step 1: Calculate the dividend for FY 2012 Dividend 3.21 Step 2: Calculate the stock for FY 2012 Stock Value 107 Step 3: Calculate the stock value with a ZERO growth rate Stock Value 32 Step 4: Calculate the stock value due to dividend growth Stock Value with Growth 107 Stock Value without Growth 32 Stock value due to dividend growth 75 Condition for the model to work: > k e must be greater than growth rate (g) and > the k e & g should remain constant forever i.e they are never expected to change. Condition for the model to work: must be greater than growth rate (g) and > the k e & g should remain constant forever i.e they are never expected to change.