Which of the following statements is true?
A) In order for the constant growth dividend model to properly value a firm's common stock, R must be greater than g.
B) From a practical perspective, the growth rate in the constant growth dividend model must be greater than the sum of the long-term rate of inflation and the long-term real growth rate of the economy.
C) In order for the constant growth dividend model to properly value a firm's common stock, g must be greater than R.
D) The constant growth dividend model can be used effectively to value the common shares of a mixed growth stock.

Question

Quizplus · Accepted Answer

The constant growth dividend model (also known as the Gordon Growth Model) assumes that dividends grow at a constant rate in perpetuity. For the model to work and not result in a negative stock price or an unrealistic valuation, the required rate of return (R) must be greater than the dividend growth rate (g). This is because the model is based on the premise that the value of the stock is the present value of all future dividends, which must be discounted at a rate higher than they grow, to ensure the present value sums to a positive number.

Which of the Following Statements Is True