Question

Which of the following statements is most correct? Select one:

a. The constant growth model is often appropriate for companies that the dividend growth rate is larger than its required rate of return on stock.

b. The constant growth model is often appropriate for companies that never pay dividend.

c. Two firms with the same dividend and growth rate should have the same stock price.

d. The constant growth model can be applied to companies that expect zero dividend growth rate. e. The constant growth model is inappropriate for mature companies with a stable history of growth.

is A correct?

Answer 1

Answer - Option D

Statement a is incorrect. This is because if growth rate is larger than required rate, the denominator would be negative yielding a negative stock price, which is not possible.

Statement b is incorrect. This model is applicable only for companie that pay dividends, since numerator needs dividend.

Statement c is incorrect. The third element in formula, required return could be different for 2 stocks and hence yield a different stock price.

Statement d is correct. If growth rate = 0, both numerator and denominator would still produce acceptable results.