Question

1- The constant perpetual growth model assumes the:

A- dividends are paid for a stated number of years only.
B- net income is all paid out in dividends.
C- growth rate is less than the discount rate.
D- dividends are constant in amount.
E- discount rate increases at a constant rate.

Answer 1

Constant perpetual growth model :

P0 = D1/(ke-g)

As the name suggests, dividends are growing at a constant for infinite number of years. Dividend is gorwing at a constant growth rate. And most important, growth rate is less than the discount rate, otherwise model will fail, as price will be negative. Discount rate does not change. As growth rate is there in dividends, not all dividends are paid out.

So correct answer : Growth rate is less than the discount rate

Answer : C : growth rate is less than the discount rate