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Gordon Growth Model:
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The cost of equity represents the return a company must offer investors to compensate for the risk of investing in its stock. The Gordon Growth Model (Dividend Discount Model) is one method to estimate this cost.
The calculator uses the Gordon Growth Model:
Where:
Explanation: The model assumes dividends will grow at a constant rate indefinitely. The first term represents the dividend yield, while the second term accounts for growth.
Details: Cost of equity is crucial for capital budgeting decisions, company valuation, and determining the weighted average cost of capital (WACC). It helps investors assess whether an investment meets their required rate of return.
Tips: Enter expected annual dividends per share in dollars, current stock price in dollars, and expected constant growth rate as a percentage. All values must be positive (price must be greater than zero).
Q1: What are typical cost of equity values?
A: Typically ranges from 8% to 20% for most companies, with higher-risk companies having higher costs of equity.
Q2: What are limitations of the Gordon Model?
A: Assumes constant dividend growth forever, which may not be realistic. Works best for mature, stable companies with consistent dividend policies.
Q3: How does this compare to CAPM?
A: CAPM considers market risk (beta) and risk-free rate, while Gordon Model focuses on dividends. They often provide different estimates.
Q4: What if a company doesn't pay dividends?
A: The Gordon Model cannot be used for non-dividend-paying companies. Other methods like CAPM or earnings capitalization would be more appropriate.
Q5: How sensitive is the model to growth rate?
A: Very sensitive - small changes in growth rate assumptions can significantly affect the calculated cost of equity.