Which of the following statements is correct?
a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.
b. Two firms with the same expected dividend and growth rates must also have the same stock price.
c. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant.
d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock%u2019s dividend yield is also 5%.
e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
Constant Growth Dividend Discount Model:
This problem requires a general understanding of the constant growth dividend discount model, which is also referred to as the Gordon Growth Model. It is a widely used stock valuation model, which computes the fair value of a stock as the sum of all future dividends, discounted using an appropriate rate.
Answer and Explanation:
The formula for the dividend discount model (DDM) is provided below. To utilize it, the growth rate of a company's dividends must be assumed to be constant.
P0 = D1/(r-g)
P0 = intrinsic value of stock
D1 = dividend payment one year from today
r = discount rate
g = growth rate
Based on the information above, the correct answer is "a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock." While capital gains are not explicitly expressed in the DDM, the model is reflective of the intrinsic value of a stock. All sources of value are embedded in the dividend and growth rate assumptions.
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from Finance 101: Principles of FinanceChapter 14 / Lesson 3