Question

1. Which of the following changes would cause a stock price to increase?
   1. Increase to the dividend growth rate
   2. Increase to the stock’s beta
   3. Increase to the required rate of return
   4. Increase to the risk-free rate

Answer 1

Answer: [A] Increase to the dividend growth rate

Explanation:

Per the "Constant Dividend Growth Model" of stock valuation, the price of a stock is gven by:

P0 = D1/(r-g), where D1 = the next expected dividend, r = the required rate of return and g = the growth rate.

The required return per CAPM = risk free rate+beta*market risk premium

When the required return increases, the the value of the denominator increases and P0 will decrease. The increase in risk free rate or the beta increase the required return, and hence will reduce the price.

But, if g increases, the value of the denominator in the above equation decreases thereby pushing up the price.