annasmom, you're correct that with zero growth the Gordon Growth Model simplifies to the value of a perpetuity, and that this theory is almost certainly an over-simplification of what could transpire in reality. Nonetheless, here's my understanding of the theory:
If a firm is paying 100% of its dividends to shareholders, it's foregoing the opportunity to invest in positive-NPV projects, acquisitions, or other transactions that could increase the firm's size and eventually translate into growing dividends. Bottom line: barring some sort of intervention, this firm and its dividends aren't going to grow.
Moreover, what sort of firm would have such a high payout ratio? Almost certainly it's a large, profitable firm in a mature industry that frankly isn't faced with many positive-NPV investment opportunities in its core operating areas. Perhaps it could grow by acquiring market share (other firms). I think it's what the BCG Growth-Share Matrix would call a "cash cow."
When you study Dividend Policy, you'll see that a 100% payout ratio probably isn't a great idea because investors seem to favor predictable payments.
You'll also encounter the equation: g = RR * ROE
A firm's sustainable growth rate is its earnings retention rate (in this case zero) * its ROE. I think this assumes no new equity is issued, among other things, but someone like JoeyDVivre who's stronger in mathematics and these theories than I will have to chime in.
In any case, I hope that helps. Just keep in mind that much of the theory you're learning is conceptually accurate, interesting, but doesn't necessarily hold in reality. It's good to see that you understand the Gordon Growth Model, because you'll be using several variations of it when you reach Level II.
Good luck!
Edited 1 time(s). Last edit at Saturday, July 21, 2007 at 01:41PM by hiredguns1.