Question

In a two-stage dividend growth model, it is commonly assumed that dividend growth drops from a high rate in the first stage to a low perpetual growth rate in the second stage. Discuss the reasonableness of this assumption and what happens if this assumption is violated.

Answer 1

It is the notional assumption of two-stage dividend growth model. Two-stage dividend growth model works on the assumption that the dividend grows more on first phase than it's growth rate decreases to its perpetuity in the second phase. It is considered that business is growing in the first phase causing high returns whereas second phase starts when business reaches to it's peak (or We can say, when business stabilizes); in steady period the returns are less but perpetual in nature which second phase refers to.

Thus, rational phenomenon of two-stage dividend growth model considered high returns in the first phase & steady and low perpetual returns in the second phase.

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This assumptions or phenomenon violates due to arisen of any of below mentioned circumstances:

1. Natural Climatic Disaster - Any natural disaster that hamper the business resources might impact business growth and stability which might lead to violation of the above assumption.

2. Political Changes - Any changes in the Governmental rules and regulations that impact the business operations and it's resources also lead to uneven business growth.

3. Industry Rivals: Any giant industry player might takes advantage of it's scale in terms of capturing potential markets - that ultimately impact on business profitability and growth.

4. Breakdown of Business: As in today's world we are seeing many startups breakdowns too early due to either lack of financial resources and expertise or lack of implementation of business idea - that might also affect business growth and profitability on a higher scale.