# Which of the following statements is correct? a. The constant growth model takes into...

## Question:

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.

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)

Where,

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.