Gordon Growth Model

The Gordon growth model is the constant growth form of the dividend discount model. It assumes dividends grow at one steady rate forever. Myron Gordon and Eli Shapiro published it in 1956, and for cost of equity it is written as Ke = D1 / P + g.

D1 is next year's dividend, P is the share price and g is the growth rate. With P at $50, a current dividend of $2.00 and g at 4%, D1 is $2.08 and Ke is 4.16% + 4% = 8.16%. The dividend yield is the first half of the formula.

Growth has to stay below the cost of equity, or the math breaks. Small changes in g swing the result a lot, so test a range. The cost of equity calculator has a dividend growth tab, and the FAQ on whether cost of equity is the same as CAPM compares the two results. See also the dividend discount model.