Question

The dividend growth model: a. can be used to value both dividend-paying and non-dividend-paying stocks. b. cannot be used to value constant dividend stocks. c. requires the growth rate to be less than the required return. d. only values stocks at Time 0. assumes dividends increase at a decreasing rate.

Answer 1

Answer:

c. requires the growth rate to be less than the required rate of return

Explanation:

The Dividend growth model was formulated by Myron Gordon.

The model helps in determination of market price of a stock ($P_{0}$ )

It is given by the following formula:

$P_{0} = \frac{D_{0}(1\ +\ g) }{K_{e}\ -\ g }$

where $P_{0}$ = Current market price per share/stock

$D_{0}$ =  Last paid dividend per share

g = annual growth rate in dividends denoted in percentage

$K_{e}$ = Cost Of Equity or Investor's required rate of return

The model assumes constant rate of growth in dividends. Another major shortcoming of the model being it's assumption of constant required rate of return of the investors.

One of the assumptions of Dividend Growth Model is,

Dividend Growth Rate < Required rate of return