Final answer:
The rearranged constant-growth-rate discounted dividend model equation (k = g + (D₁/P₀)) reveals the required rate of return on a stock is the sum of the dividend yield and the growth rate. This equation aids investors in assessing the value of a stock based on future dividends.
Step-by-step explanation:
The constant-growth-rate discounted dividend model, commonly referred to in finance as the Gordon Growth Model, helps in determining the value of a stock with dividends that are expected to grow at a constant rate. This can be described by the formula P₀ = D₁ / (k - g), which can be rearranged to k = g + (D₁/P₀). Here, P₀ represents the present value or price of the stock, D₁ is the dividend expected in the next period, k stands for the required rate of return or discount rate, and g symbolizes the constant growth rate of the dividends.
When the formula is rearranged to k = g + (D₁/P₀), it reveals that the required rate of return is composed of two parts: the dividend growth rate (g) and the dividend yield (D₁/P₀). A higher dividend yield or a higher growth rate would justify a higher stock price for a given level of return.
Another way to think about growth in financial terms is to consider the compound growth rate, which is related to the concept of compound interest rates. Whether you are calculating the growth of savings in an account or dividends from stocks, the formula is Future Value = Present Value x (1 + g)^n, where n represents the number of periods over which the value grows.