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Dividend Policy Analysis

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Gordons model
The dividends of most companies are expected to grow and evaluation of
value of shares based on dividend growth is often used in valuation of
shares. Dividend valuation model assumes a constant level of growth in div
in perpetuity. The Gordon growth model is theoretical model used to value
ordinary equity shares. The model incorporates the retention of earnings
and growth of dividends and hence it is called as ‘dividend growth valuation
model’. The main proposition of the model is that the value of shares
reflects the value of future dividends accruing to that share. Hence, the
dividend payments and its growth are relevant in valuation of shares. The
model holds that share’s market price is equal to the sum of shares
discounted to the sum of share’s discounted future dividend payments.
Assumptions:-
Gordon growth valuation model using dividend capitalization is based on
the following assumptions:-
1. The firm is an all equity firm and has no debt.
2. External financing is not used in the firm. Retained earnings
represent the only source of financing.
3. The internal rate of return is the firms cost of capital ‘k’. it remains
constant and is taken as the appropriate discount rate.
4. Future annual growth rate dividend is expected to be constant.
5. Growth rate of the firm is the product of retention ratio and its rate of
return.
6. Cost of capital is always greater than the growth rate.
7. The company has perpetual life and the stream of earnings are
perpetual.
8. The retention ratio ‘b’, once decided upon, remains constant.
Therefore, the growth rate g = br is also constant forever.
In valuation of share under Gordon growth model, the following formula is
used:-
P
0
= D
0
(1+g)/ke-g
= D
1
/ke-g

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Gordons model The dividends of most companies are expected to grow and evaluation of value of shares based on dividend growth is often used in valuation of shares. Dividend valuation model assumes a constant level of growth in div in perpetuity. The Gordon growth model is theoretical model used to value ordinary equity shares. The model incorporates the retention of earnings and growth of dividends and hence it is called as ‘dividend growth valuation model’. The main proposition of the model is that the value of shares reflects the value of future dividends accruing to that share. Hence ...
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