medium · CFA Level I equity
Nadir Components is a manufacturer of semiconductor parts with a sustainable ROE of 15% and a dividend retention rate of 60%. The firm’s required return on equity is 12%. Nadir’s management is considering a new project that would increase ROE to 18% but require a higher retention rate of 80%.
If Nadir's new sustainable growth rate is 14.4% while the required return remains 12%, what is the primary limitation of using the Gordon Growth Model (GGM) to value the firm?
- The model will produce a negative value because g > r
- The model will underestimate the value because it ignores the retention rate
- The model is only suitable for firms in the 'Shakeout' stage
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