The underlying assumption of the dividend growth model is that a stock is worth:
A)the same amount to every investor regardless of their desired rate of return.
B)the present value of the future income that the stock is expected to generate.
C)an amount computed as the next annual dividend divided by the market rate of return.
D)the same amount as any other stock that pays the same current dividend and has the same required rate of return.
E)an amount computed as the next annual dividend divided by the required rate of return.

Question

Quizplus · Accepted Answer

The underlying assumption of the dividend growth model is that the value of a stock is equal to the present value of its expected future dividends, discounted at an appropriate rate. In other words, the stock is worth the present value of the cash flows it is expected to generate in the future. Therefore, option B is the correct answer. Option A is incorrect because different investors may have different required rates of return, leading to different valuations of the stock. Option C is incorrect because the dividend growth model takes into account not only the next dividend but all future dividends. Option D is incorrect because two stocks with the same dividend and required rate of return can have different future growth prospects, leading to different valuations. Option E is incorrect because the dividend growth model assumes that the dividend will grow at a constant rate, not necessarily equal to the required rate of return.

The Underlying Assumption of the Dividend Growth Model Is That