GORDON’S MODEL

ABHISHEK STEPHEN. F

DEFINITION

According to Prof. Gordon, Dividend Policy almost

always affects the value of the firm. He Showed how

dividend policy can be used to maximize the wealth of

the shareholders.

The main proposition of the model is that the value of a

share reflects the value of the future dividends accruing

to that share. Hence, the dividend payment and its

growth are relevant in valuation of shares.

The model holds that the share’s market price is equal

to the sum of share’s discounted future dividend

payment.

ASSUMPTIONS

Gordon’s model is based on the following assumptions:

The firm is an all Equity firm

No external financing is available

The internal rate of return (r) of the firm is constant.

The appropriate discount rate (K) of the firm remains constant.

The firm and its stream of earnings are perpetual

The corporate taxes do not exist.

The retention ratio (b), once decided upon, is constant. Thus, the growth rate (g) = br is constant forever.

K > br = g if this condition is not fulfilled, we cannot get a meaningful value for the share.

Formula of Gordon’s

Model

Where,

P = Price

E = Earning per Share

b = Retention Ratio

k = Cost of Capital

br = g = Growth Rate

P =E (1 – b)

K - br

CALCULATION OF MARKET PRICE PER

SHARE

BAJAJ STEEL COMPANY LTD – 2013

R=18.95 K=.5 EPS=92.35 DPS=4

ASSUMPTION ORIGINAL DATA LET R BE 15.95% LET R BE .5%

PART

PAYMENT91.3%

4.5 5.4 184.9

100%

RETENTION

4.8 5.7 184.9

100% PAYOUT 4.7 5.5 184.9

BAJAJ STEEL COMPANY LTD – 2014

R= 8.09 K=.5% EPS=53.62 DPS=4

ASSUMPTION ORIGINAL DATA LET R BE 4 .09% LET R BE .5%

PART PAYMENT

52.62%

6.5 12.8 107.2

100%

RETENTION

6.6 13.4 107.2

100% PAYOUT 6.2 13.1 107.2

BAJAJ STEEL COMPANY LTD- 2015

R=4.OO K=10.1% EPS=100 DPS=0

ASSUMPTION ORIGINAL DATA LET R BE 2% LET R BE 10.1%

PART

PAYMENT0.99

0.25 0.52 0.09

100%

RETENTION

0.25 .52 0.09

100% PAYOUT 0.21 1.10 0.09

DATA INTERPRETATION

BAJAJ STEEL According to Gordon’s Model, this company is a

declining firm because the r<k (4.00%<10.1%)

Since the market price is lower (0.21) as calculated

through the Gordon’s formula, the researcher has

found that the Gordon’s model is disproved for all

the 3 years.

CALCULATION OF MARKET PRICE PER

SHARE

TATA CONSTUTANCY SERVICES- 2014

R=53.39 K=33.09 EPS=66.03 DPS=32.00

ASSUMPTIONS ORIGINAL DATA LET R BE 50.39% LET R 33.09%

PART PAYMENT

.65

0.01 130 3.7

100% RETENTION 1.23 1.31 3.7

100% PAYOUT 0.01 0.01 3.7

TATA CONSTUTANCY SERVICES-

2015

R=52.77% K=79.26% EPS=17.38 DPS=79.00

ASSUMPTIONS ORIGINAL DATA LET R BE 47.77% LET R 79.26%

PART PAYMENT

16.3

0.30 0.21 0.20

100% RETENTION 0.32 0.28 0.20

100% PAYOUT 0.312 0.26 0.20

TATA CONSTUTANCY SERVICES-

2016

R= 49.34% K=43.56% EPS=62.55 DPS=43.50

ASSUMPTIONS ORIGINAL

DATA

LET R BE

42.34%

LET R 43.56%

PART PAYMENT

61.5

1.25 1.45 2763.6

100%

RETENTION

3034.4 2601.4 2763.6

100% PAYOUT 3096.9 2666.46 2763.6

TATA CONSULTANCY SERVICES

According to Gordon’s Model, this is a growth Firm

because the r>k (29.34 %> 43.56%)

Since the market price is lower (3034.4) as

calculated through the Gordon’s model, the

researcher has found that the Gordon’s Model is

disproved for all the 3 years.

GORDON’S MODEL

CONCLUSION

Thus the researcher has found that the

assumptions of the Gordon’s Model are disproved

for BAJAJ STEEL and TATA CONSULTANCY

SERVICES for all the 3 years, i.e.

OUTCOME

Able to test Gordon’s Model relevance for two

companies

Can able to disprove Gordon’s Model for both the

companies