Gordon's model

Gordon's model

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  GORDON’S MODEL ABHISHEK STEPHEN.F
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  DEFINITION  According toProf. 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.
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  ASSUMPTIONS Gordon’s model isbased 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.
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  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
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  CALCULATION OF MARKETPRICE 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
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  BAJAJ STEEL COMPANYLTD – 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
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  BAJAJ STEEL COMPANYLTD- 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
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  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.
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  CALCULATION OF MARKETPRICE 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
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  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
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  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
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  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.
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  GORDON’S MODEL CONCLUSION Thus theresearcher 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