Question

Which of the following will cause the stock price to increase if you assume that the constant growth pricing model [P(0) = D(1) / (r(s) – g)] is correct:

a. Decrease in Dividends
b. Increase in the required rate of return
c. Increase in the growth rate
d. Increase in the Required Rate of Return and Decrease in dividends

Answer 1

c. Increase in the growth rate

Step-by-step explanation:

we can use an example to illustrate how this works:

Div₁ = $2

r = 10%

g = 2%

P₀ = $2 / (10% - 2%) = $25

if g increases from 2% to 4%, even if nothing else changes,

P₀ = $2 / (10% - 4%) = $33.33

An increase in g decreases the denominator and that will always result in a larger number.