Post uses Gordon growth model to evaluate how timing
of the initiation of dividend payments affects Gordon growth model firm
valuations.
Question: A firm with an 11 percent cost of capital
currently does not pay any dividends.
What is the Gordon Growth model estimate of firm value if the firm
initiates a $3.00 dividend and an annual dividend growth rate of either 2% or
4.0% annual increase in dividends in 2, 3, or 4 years?
What is the estimated Gordon
Growth valuation in these situations when the cost of capital is 12 percent?
Analysis: Two steps.
First find the value of the stock on the day dividends are
initiated. This is P/(DG). Second, discount the value of P back to current
time. This is P/(1+R)^{t} where t is the number of years to initiation of
dividends.
Here are the calculations.
Company 1

Company 2

Company 3

Company 4


D

$3.00

$3.00

$3.00

$3.00

R

0.11

0.11

0.12

0.12

G

0.04

0.02

0.04

0.02

Undiscounted Valuation

$42.86

$33.33

$37.50

$30.00

Year Dividends are
initiated

Discounted Values


2

$34.78

$27.05

$29.89

$23.92

3

$31.34

$24.37

$26.69

$21.35

4

$28.23

$21.96

$23.83

$19.07

Impact of two year delay
for four scenarios

18.84%

18.84%

20.28%

20.28%

Background: The Gordon Dividend Growth Model treats the
value of a stock as the discounted value of all future dividends.
The formula for the
value of the stock can be written as
P=D/(RG)
P is the value of
the stock,
D is the annual
dividend,
R is the required
cost of equity,
G is the growth rate
of dividends.
Note
that with RG in the denominator the estimated share price will become quite
large when G becomes almost as large as R.
The price will be negative, a nonsensical result, if G>R.
Resource on Gordon
Growth Model.
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