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Growth rate in dividends = retention rate * investment rate
When i tried to put values say
$1000 =PAT
20% retention
10% investment
2? =g that is $20 out of $1000 ( profits).This g is OF PAT ,BUT it will be used as a growth rate on dividends which seemed to me as wrong.( 800 dividends* 2% = 16)
So is this why it is called gordon growth APPROXIMATION.? (If yes, then i get it)
If not , id like to understand why a rate out of profits can be used as a dividend growth.
On your example the growth rate is 2% each year.
If profits grow at 2% a year, and they maintain the same retention policy, then dividends will automatically grow at 2% a year as well.
If you look at page 88 of our free Paper F9 lecture notes then you will see a worked illustration of how it works (it is in the F9 notes because it is revision from F9).
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