This
post uses the Gordon growth model to back out estimates of sustainable dividend
growth for three utilities.
Question: The chart below has information on price per
share and dividend per share for three utilities. Assume that all three utilities have the same
cost of capital 9 percent. What
dividend growth rate justifies these share prices based on the basic Gordon
growth model?
Share Price and Dividend
Per Share for Three Utilities


Price Per Share

Dividend Per Share


Next Era

190.1

5

Duke

90.5

3.7

Dominion Power

77.5

3.4

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.
Resource on Gordon Growth Model.
Analysis:
We have values for P and D in the table and we are assuming R is 0.09.
Rearranging the Gordon Growth model formula to
get
(PRD)/P
= G
Calculation of G the estimated growth rate in
dividends is below.
Share Price and Dividend
Per Share for Three Utilities


Price Per Share

Dividend Per Share

Estimated Dividend Growth Rate(PRD)/P


Next Era

190.1

5

6.37%

Duke

90.5

3.7

4.91%

Dominion Power

77.5

3.4

4.61%

R

0.09

Key assumption is a 9 percent cost of
capital. Spreadsheet is set up so one
can alter the cost of capital assumption.
Can Next Era provide a 6.4% growth rate in Dividends
to sustain its current share price? A
more complete analysis would consider whether Next Era has a lower cost of
capital than the other two utilities.
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