Explain the relationship observed between the required rate of return, growth rate and the dividend paid, and the estimated value of the stock using the Gordon Model.

Need help with valuation of financial instruments

The Gordon Model is a formula used to estimate the value of a company\\\’s stock. This model states that the estimated value of a stock is equal to the required rate of return multiplied by the sum of its expected future dividends, divided by the difference between its required rate of return and long-term growth rate.

In other words, this relationship shows that as one increases or decreases, so does the other; if an investor’s required rate of return rises then they will demand more dividends in order to make their investment worthwhile which will cause them to lower their estimates for a company’s stock price. Conversely, if there is an increase in expected dividends then investors will be willing to pay more for each share leading to higher valuation estimates.

Overall, this formula provides an effective way to estimate how various factors can influence the perceived value of any given stock. By understanding this relationship, investors can better assess potential investments and make educated decisions about where to allocate their funds.