A potential problem associated with the use of the dividend growth model to compute the cost of equity is that the estimated cost of equity is sensitive to the estimated dividend growth rate.

Question

Quizplus · Accepted Answer

The dividend growth model calculates the cost of equity by dividing the dividend per share expected in the next period by the current market value per share and adding the growth rate of dividends. Therefore, small changes in the estimated growth rate can significantly affect the computed cost of equity, making it sensitive to the growth rate assumption.

A Potential Problem Associated with the Use of the Dividend