The constant dividend growth formula P0 = Div1/(r - g) assumes:
I. the dividends are growing at a constant rate g forever.
II. r g
III. g is never negative.
A) I only
B) II only
C) I and II only
D) III only

Question

The constant dividend growth formula P0 = Div1/(r - g) assumes:
I. the dividends are growing at a constant rate g forever.
II. r > g
III. g is never negative.
A) I only
B) II only
C) I and II only
D) III only

Quizplus · Accepted Answer

The constant dividend growth formula assumes that the dividends will grow at a constant rate forever (I) and that the required rate of return (r) is greater than the constant growth rate (g), to ensure the stock's value does not become imaginary (II). The formula can still work if g is negative, but only if it is less than the required rate of return (r), otherwise the stock would be worthless (III is not a valid assumption).

The Constant Dividend Growth Formula P0 = Div1/(r - G)