Question

Which of the following statements is CORRECT?a. If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.b. The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.d. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.e. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.

Answer 1

B

Step-by-step explanation:

Let analyse the answer option one by one:

A. False

Recalling the dividen discounted model (DDM):

Current stock price = Next year dividend/(Required rate of return - Dividend growth rate)

Transform the formula a bit we have:

Next year dividend/Current stock price = Required rate of return - Dividend growth rate or

Dividend yield = Required rate of return - Dividend growth rate = 12% - 5% = 7%.

B. True

C. False

Stock price is the present value of all expected future dividends, discounted at cost of equity.

D. False

The constant growth model can be used for a zero growth stock, where the dividend is expected to remain constant over time. In this case:

Current stock price = Dividend/Required rate of return

E. False

This model is suitable for mature firm with stable earning growth.