Chartered Financial Analyst (CFA) Practice Exam Level 2

Which model is specifically noted for its use with stable or mature firms?

1. Discounted Cash Flow Model

2. Free Cash Flow Model

3. Gordon Growth Model

4. Economic Value Added Model

The correct answer is: Gordon Growth Model

The Gordon Growth Model, also known as the Dividend Discount Model for perpetuity, is specifically designed for valuing stable or mature firms that have predictable and consistent dividend growth. This model assumes that dividends will grow at a constant rate over time, making it particularly suitable for companies in stable industries with established business models. Mature firms often maintain a steady dividend payout as they generate stable cash flows, and the Gordon Growth Model allows analysts to determine the present value of expected future dividends. The fundamental assumption of the model is the predictability of dividend growth, which aligns well with the characteristics of stable, mature firms. While other models can be applied to various business situations, they often require more volatile estimates or growth rates, making them less ideal for stable firms. The simplicity of the Gordon Growth Model and its focus on dividend payments highlight its effectiveness in valuation when the stability of cash flows and dividends is a key factor.