Question

Using the Gordon growth model for stock valuation show what will happen to the dividend yield of a stock when the required return on the stock increases.

Answer 1

Gordon Growth Model:

P0 = D1/ (i-g)

where, P0 = current year price of share

D1 = Next year dividend payout

i = Required rate of return

g = Dividend growth rate

and Dividend Yield of stock:

Dividend paid / Market price of stock

As per Problem:

What happen to dividen yield of stock when required return increase;

when required return increase, the market price discounted at high rate means market price will reduce(as per first formula). If market price reduces the dividen yield increases (as per second formula)

So, ultimately if required return increases the dividend yield increases.