Final answer:
The dividend growth model is sensitive to the rate of dividend growth, which significantly impacts stock valuations because future dividends are projected to grow indefinitely. Historical changes in the dividend payout ratio, as shown by S&P 500 data, underscore this sensitivity. The model values stocks based on the present value of these growing dividends, alongside other potential returns like capital gains. Therefore, the correct option is O are sensitive to the rate of dividend growth.
Step-by-step explanation:
The results of the dividend growth model are often used to value stocks based on the present value of future dividends. This model incorporates various factors, but as the student has asked, it is particularly sensitive to the rate of dividend growth. The rate at which dividends grow can significantly impact the calculated value of a stock because dividends are expected to grow into perpetuity in this model.
The data from Table 17.2 suggests that dividend payout ratios have varied from about 4% in the earlier decades to 1% to 2% more recently. This implies that the sensitivity of the dividend growth rate is of paramount importance in the dividend growth model. Historically, when dividends were a larger portion of the total return, changes in the growth rate would have had a greater effect on the valuation of a stock.
An investor must also consider other factors such as potential capital gains and income over time that could accrue from stock price appreciation when applying the dividend growth model. The dividends and capital gains taken together give a total return that should be accounted for when valuing stocks. Thus, compound interest and growth rates play major roles in overall investment returns over time. Considering the information provided and the concepts of the dividend growth model, the correct answer to the student's question is that the results of the dividend growth model are sensitive to the rate of dividend growth.