Value a common share with the Gordon growth model, explaining what that model assumes
The idea
When dividends are expected to grow at a constant rate for ever, the present value of the stream simplifies to V0 = D1 ÷ (r − g), where D1 = D0 × (1 + g). The model assumes growth is constant and perpetual, that the required return exceeds the growth rate, and that dividends are the right measure of what shareholders receive. Value is very sensitive to the gap between r and g. Because value at any date is the next dividend over (r − g), the share price is also expected to grow at g. A common mistake is dividing D0 rather than D1 by (r − g), which understates value by the factor 1 + g when growth is positive.
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