Question

Based on the dividend discount model, a decrease in which of the following will lower the current intrinsic value of a stock (all else held constant)?
        I. amount of the next dividend (D₁)
        II. dividend growth rate (g)
        III. risk-adjusted discount rate (r_s)

Select one:

a. I only

b. III only

c. I and II only

d. II and III only

e.

I, II, and III

Answer 1

In dividend discount model, the current price is calculated using the formula:
Price=(Amount of the next dividend)/(Risk adjusted discount rate - Dividend growth rate)

To lower the current intrinsic value of a stock, the dividend should decrease (so that the numerator will decrease) or the growth rate should decrease (so that denominator value will increase and the price value will decrease).
The price can also come down (or become lower) if the risk adjusted discount rate increases.

Answer: Statements I and II only are correct. So, option c is correct.