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multiple theories were presented that influence capital structure decisions or dividend policy decisions affecting the price...

multiple theories were presented that influence capital structure decisions or dividend policy decisions affecting the price of a stock. Choose one of these theories and explain its strengths and weaknesses.

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Answer #1

One of the theories that explains dividend policy decisions is the Gordon Growth Model.

The formula : Market price = [ Dividend year 1 / Cost of capital - growth rate]

The formula compares the market price of the firm to the dividend and the difference between cost of capital and growth rate.

Strengths :

1. It is easier to understand and simpler to calculate.

2. It helps in comparison of the stock prices across the peer companies and industries.

3. Also, this can be applied to can array of companies and industries.

Weakness:

1. The assumption of this model is that the dividend rate remains constant, may sometimes be not appropriate.

2. Also, any changes to the values in the formula ,will change the stock price by a huge margin.

3. Non financial factors that influence the price of the stock are not considered.

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