Gordon Growth Model with dividends decreasing indefinitely

CFA Level II
#1

“I expect dividends to decline at a constant rate of 4% indefinitely”.

Is it correct that you can still apply GGM? I don’t see how this really works, since I thought the paramount assumption about GGM is that at a certain point dividends have a constant growth rate… But a negative one? How do you estimate terminal value?

The only thing I could think of would be to discount the future positive dividends and stop once they’re negative, but I’m sure this is not correct. In this case I would have concluded that GGM is not an appropriate valuation method…

Any thoughts?

#2

Of course you can apply GGM. The growth rate is −4%.

#3

Yeah, it follows. Your denomintor ends up being larger than if you had a positive rate as you’re effectively adding the growth rate (double negative) so the terminal value is much smaller.

(r-(-g) = (r+g)

#4

Thanks to both!

#5

My pleasure.