Both Ancis’s and Nutting’s statements are incorrect.
The Gordon Growth Model assumes that dividends increase at a constant rate perpetually. That fits the Low-Growth scenario, not the Middle or High-Growth scenarios. Thus, Ancis’s statement is incorrect.
In the Low-Growth scenario:
The required rate of return is (r) = 0.04 + 1.4(0.12 − 0.04) = 0.152.
The value per share is DPS
0(1 + g
n) / (r − g
n) = [(1.50)(1.03)] / (0.152 − 0.03) = $12.66.
The two-stage DDM model is most suited to a company that has one dividend growth rate for a specified time period and then shifts suddenly to a second dividend growth rate. That best fits the Middle-Growth scenario. In the Middle-Growth scenario,
The required rate of return is (r) = 0.05 + (1.4)(0.12 − 0.05) = 0.148.
The value per share is:
The two-stage DDM gives a value for AB that is ($16.44 − $12.66) = $3.78 higher than the value given by the Gordon Growth Model. Thus Nutting’s statement is also incorrect
