Question

The growing cash stream model is a simplification of reality for all the following reasons except:

A.No company grows at a constant rate forever.

B.Some companies grow at rates greater than their cost of equity capital.

C.Not all companies pay dividends.

D.The cost of equity capital is impossible to calculate.

Answer 1

Answer-

The correct option is D. The cost of equity capital is impossible to calculate.

The cost of equity capial can be calculated by CAPM as

Cost of equity capital = Rf + Beta x (Rm - Rf)

Where
Rf = risk free rate
Rm = market return

The other options are all Correct.

Option A- The company can grow at higher rates initially and the rate decreases in mature stage and cannot grow at a constat rate forever.

Option B - The company can grow at a rate higher than the cost of equity capital as debt or leverage increases and the overall rate of growth can be higher compared to cost of equity capital.

Option C - There are some companies that do not pay dividends and use this cash for the use of investment in the growth projects which increases the value of firm and stock price thus increasing the shareholders wealth.