{"id":18062,"date":"2021-07-20T06:21:49","date_gmt":"2021-07-20T06:21:49","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=18062"},"modified":"2026-05-08T20:01:56","modified_gmt":"2026-05-08T20:01:56","slug":"estimating-the-required-rate-of-return-using-any-ddm","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/estimating-the-required-rate-of-return-using-any-ddm\/","title":{"rendered":"The Required Rate of Return the Gordon Growth Model and the H-model"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"A security has an expected dividend of $2.50, a current price of $38, and an expected growth rate of 5%. What is the required rate of return closest to?\",\r\n    \"text\": \"For a security with an expected dividend of $2.50, a current price of $38, and an expected growth rate of 5%, the required rate of return would be closest to:\",\r\n    \"answerCount\": 3,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"11.58%\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"9.5%\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"11.58%\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"15.55%\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/fiJA5WhgigU\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n\r\n<p>Given all the inputs to a dividend discount model (DDM) except the required return, the IRR can be calculated and used as a substitute for the required rate of return. This IRR can be interpreted as the expected return on the issue implied by the market price.<\/p>\r\n<h2>The Gordon Growth Model<\/h2>\r\n<p>Using the Gordon growth model, the required rate of return can be calculated as:<\/p>\r\n<p>$$\\text{r}=\\frac{\\text{D}_{1}}{\\text{P}_{0}}+\\text{g}$$<\/p>\r\n<h4>Example: Estimating the Required Rate of Return<\/h4>\r\n<p>If a security has a current dividend of $1.50, a current price of $25, and an expected growth rate of 4%, then the required rate of return would be:<\/p>\r\n<p>$$\\begin{align*}\\text{r}&amp;=\\frac{1.50(1.04)}{25}+0.04\\\\&amp;=10.24\\%\\end{align*}$$<\/p>\r\n<h2>The H-model<\/h2>\r\n<p>Using the H-model, the required rate of return can be calculated as:<\/p>\r\n<p>$$\\text{r}=\\bigg(\\frac{\\text{D}_{0}}{\\text{P}_{0}}\\bigg)[(1+\\text{g}_{\\text{L}})+\\text{H}(\\text{g}_{S}-\\text{g}_{\\text{L}})]+\\text{g}_{L}$$<\/p>\r\n<h4>Example: Estimating the Required Rate of Return<\/h4>\r\n<p>If a security has a dividend of $1.50, a current price of $25, and an expected short-term growth rate of 10% declining linearly over 10 years to 6%, then the expected rate of return would be:<\/p>\r\n<p>$$\\begin{align*}\\text{r}&amp;=\\bigg(\\frac{1.50}{25}\\bigg)[(1.06)+5(0.04)]+0.06\\\\&amp;=13.56\\%\\end{align*}$$<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>For a security with an expected dividend of $2.50, a current price of $38, and an expected growth rate of 5%, the required rate of return would be <em>closest<\/em> to:<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>9.5%.<\/li>\r\n\t<li>11.58%.<\/li>\r\n\t<li>15.55%.<\/li>\r\n<\/ol>\r\n<h4>Solution\u00a0<\/h4>\r\n<p><strong>The correct answer is B.<\/strong><\/p>\r\n<p>$$\\begin{align*}\\text{r}&amp;=\\frac{\\text{D}_{1}}{\\text{P}_{0}}+\\text{g}\\\\ \\\\&amp;=\\frac{2.50}{38}+0.05\\\\ \\\\&amp;=11.58\\%\\end{align*}$$<\/p>\r\n<\/blockquote>\r\n<p>Reading 23: Discounted Dividend Valuation<\/p>\r\n<p><em>LOS 23 (n) E<\/em><em>stimate a required return based on any DDM, including the Gordon growth model and the H-model.<\/em><\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>Given all the inputs to a dividend discount model (DDM) except the required return, the IRR can be calculated and used as a substitute for the required rate of return. This IRR can be interpreted as the expected return on&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[216,402,454,440],"class_list":["post-18062","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-cfa-level-2","tag-equity-valuation","tag-estimating-the-required-rate-of-return-using-any-ddm","tag-reading-27-discounted-dividend-valuation","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Required Rate of Return and H-Model | CFA Level II<\/title>\n<meta name=\"description\" content=\"Learn how to estimate the required rate of return using dividend discount models, including the Gordon Growth 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