Question

The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows: Di (rs - 9) Which of the following statements is true? Increasing dividends will always decrease the stock price, because the firm is depleting internal funding resources ) Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth. Increasing dividends will always increase the stock price. Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $1.25 at the end of the year. Its dividend is expected to grow at a constant rate of 7.50% per year. If Walter's stock currently trades for $20.00 per share, what is the expected rate of return? ? 8.03% ? 7.56% ? 13.75% ? 9.25% Which of the following statements will always hold true? O The constant growth valuation formula is not appropriate to use for zero growth stocks. O It will never be appropriate for a rapidly growing startup company that pays no dividends at present-but is expected to pay dividends at some point in the future-to use the constant growth valuation formula. The constant growth valuation formula is not appropriate to use unless the company's growth rate is expected to remain constant in the future.

Answer 1

Which of the following statements is true?

• Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth.

If the firm starts to distribute too much money in dividends, it will reduce its retained earnings which are needed to finance existing and future projects which will generate growth.

Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $1.25 at the end of the year. Its dividend is expected to grow at a constant rate of 7.50% per year. If Walter's stock currently trades for $20.00 per share, what is the expected rate of return? ?

• 13.75%

the Gordon growth model:

stock price = dividends / (required rate of return - growth rate)

$20 = $1.25 / (RRR - 7.5%)

RRR - 7.5% = $1.25 / $20 = 6.25%

RRR = 6.25% + 7.5% = 13.75%

Which of the following statements will always hold true?

• The constant growth valuation formula is not appropriate to use unless the company's growth rate is expected to remain constant in the future.

This formula is only appropriate if the growth rate is constant, if it changes over time, the formula should be adjusted every time the growth rate changes.