In: Finance
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) / (Ke - 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., (Ke - 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.