In case, cost of capital is 10%, EPS ₹ 10, IRR 8% and Retention Ratio is 60%, then the value of equity share as per Gordon’s Model will be :
₹ 77
Gordon's model values a share as the present value of an infinite stream of dividends growing at a constant rate, where growth comes from retained earnings reinvested at the firm's rate of return.
The formula is \( P_0 = \dfrac{E(1-b)}{k - br} \), where E is EPS, b the retention ratio, r the internal rate of return (IRR) and k the cost of capital.
Here \( E = 10 \), \( b = 0.6 \), \( r = 0.08 \) and \( k = 0.10 \). Dividend per share \( = E(1-b) = 10 \times 0.4 = 4 \).
Growth rate \( g = br = 0.6 \times 0.08 = 0.048 \).
\( P_0 = \dfrac{4}{0.10 - 0.048} = \dfrac{4}{0.052} \approx 76.92 \approx 77 \).
Because r \( \lt \) k, retaining earnings lowers value; with full payout the share would be worth \( 10/0.10 = 100 \), which shows Gordon's point that a declining firm should pay out more.
Hence, ₹ 77.
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