Which of the following are key assumptions of Gordon’s Dividend Model?

A. Ke > br

B. r and Ke are changing

C. The firm is not all-equity firm

D. The firm has perpetual life

E. The retention ratio, once decided, is constant

Choose the correct answer from the options given below:

Correct option is A

Gordon’s Dividend Model (also known as Gordon’s Growth Model or Dividend Discount Model) explains the relationship between dividends, growth, and stock valuation. It assumes that a firm’s value depends on the present value of future dividends.
Ke > br (Correct)
This is a fundamental assumption of Gordon’s Model. Here:
Ke = Cost of equity capital
b = Retention ratio
r = Rate of return on new investment
For the model to be valid, the cost of equity must be greater than the growth rate of earnings ( br), ensuring that dividends contribute to valuation.
(B) r and Ke are changing (Incorrect)
Gordon’s Model assumes that r (rate of return) and Ke (cost of equity) are constant, not changing.
(C) The firm is not an all-equity firm (Incorrect)
Gordon’s Model assumes the firm is an all-equity firm, meaning it does not take debt into account.
(D) The firm has perpetual life (Correct)
The model assumes the firm operates indefinitely, allowing for the calculation of stock value based on infinite dividend payments.
(E) The retention ratio, once decided, is constant (Correct)
Gordon assumes that the firm maintains a stable retention ratio (b) over time, leading to constant growth in dividends.
Information Booster:
Key Assumptions of Gordon’s Dividend Model:
Ke > br: The cost of equity must be greater than the growth rate for the model to work.
Constant growth rate: The firm’s earnings grow at a constant rate.
No external financing: All investments are financed through retained earnings.
Perpetual life: The firm continues indefinitely.
All-equity firm: No debt is considered in the model.
Constant retention ratio (b): The firm maintains a fixed proportion of retained earnings