Proof for the Gordon Model


(1  g ) t 1
PV = 
t 1
D1
(1  r ) t

On the right side of the equation, divide D1 by (1 + g) and multiply the right-hand term by (1 + g) to have a
1 g
consistent exponent for the right-hand term (the effect is to multiply the right side by ).
1 g

 t
D1  1  g 
PV = 
t 1
 
1 g  1 r 
where g < r (if g > r, the right-hand term goes to infinity).

This is an infinite geometric series that can be simplified by using a geometric expansion. First, expand the
terms in the equation by removing the summation symbol.

D1  1  g   1  g  2  1  g  3  1 g  

1 g
PV =       ...     Multiply this equation by .
1 g  1  r   1  r   1 r   1  r   1 r

1 g  D1  1  g  2  1  g  3  1  g  4 1 g 
 1 
PV   =          ...     Subtract this from the first
 1  r  1  g  1  r   1 r   1 r   1 r  
equation

1 g  D1  1  g   1  g   1 
PV - PV   =     Factor out PV on the left side of the equation.
 1 r  1 g  1  r   1  r  

 1
  1  g  D1  1  g   1 g 
PV 1    =   where   = 0.
  1  r  1 g  1 r   1 r 

Isolate PV by dividing both sides of the equation by the right-hand term on the left side.

  1 g  
   
D1   1  r   1 r
PV = Multiply the right side of the equation by to simplify the right-hand
1 g  1 g   1 r
1   
  1 r  
term.

  1 g  
   
D1   1  r   1 r  D1  1 g 
PV =   =  
1 g  1 g    1  r     
1 g  1 r  1 g 
1   
  1 r  

Simplify the denominator in right-hand term of the right side of the equation.
 D1  1 g  D1
PV =   = where g < r.
1 g rg rg