There are two basic assumptions concerning the growth rate that underlie the dividend growth model. Identify...

There are two basic assumptions concerning the growth rate that underlie the dividend growth model. Identify one of these assumptions and explain why the assumption is logical.

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Expert Solution

There are two basic assumption concerning the growth rate that underlie the divident growth model. One of the assumption are -

1. Dividend growth Model is also known as Gorden's Model. In this Model, the dividend growth rate is constant.In most of the cases, Companies earning and growth rate are not known but they are constant. In Dividend growth Model, the growth rate is not greater than Required rate of Return.

The example of Dividend Growth Model is -

P₀ =

Where,

DPS = Expected Dividend for the next year

Ke = Capitalisation Rate, Required rate of Return or Cost of equity

G = Growth Rate.

There are three types of Dividend Discount Models. They are-

1. Positive Dividend Discount Rate =

2. Negative Dividend Discount Rate =

3. Zero Dividend Discount Rate =

This Model is assume that the investors are not willing to take any risk and prefer more and more returns. And most of the basic assumptions of this Model.

The life of a company or firm is perpectual i.e. going concern.

The Rate of Return (r) and cost of capital (Ke) are constant.

Growth rate are constant.

These are the basic assumptions of dividend growth model or Gorden's Model.

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