the dividend growth model is only useful for estimating a stocks value when the stocks beta...

the dividend growth model is only useful for estimating a stocks value when the

stocks beta is strictly less than the market beta

stocks required return is strictly less than the constant growth rate in dividends

stocks growth rate in dividends is strictly greater than zero

stocks pay dividends

Solutions

Expert Solution

Answer: Option (4) The dividend growth model is only useful for estimating a stocks value when the stocks pay dividends.

Explanation:

As per dividend growth model, Price of share is the present value of all the dividends by taking growth rate into consideration.

Price of a Share if dividends are growing at Constant Rate, P₀ = D₁ (1+g) / (K_e - g)

The dividend growth model is only useful for estimating a stocks value when the stocks pay dividends, as if the stocks are not paying dividend, D₁ = 0, which implies the share price is 0, which is incorrect.

Stocks growth rate in dividends need not be strictly greater than zero, as if the growth rate can even be 0 or less than zero, the Price can be defined.

If the stocks required return is strictly less than the constant growth rate in dividends, the denominator i.e., (K_e - g) will become zero or negative, which makes the formula undefined.

Stocks beta is strictly less than the market beta, is not a valid statement as the Stock Beta is no where considered in the process of defining Price of the share using dividend growth model.

jeff jeffy answered 1 year ago

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