The dividend growth model equates a stock’s intrinsic value (theoretical price)

Question

The dividend growth model equates a stock’s intrinsic value (theoretical price) to the discounted sum of the constant growth dividend stream. The relationship between the dividend growth rate (g) and the discount rate (r) is very important. Which statement accurately describes that relationship?

Select one:

a. I When g equals zero percent then the stocks intrinsic value is less than div/r.

b. I, II, and III are all correct

c. III The stock’s intrinsic value is an increasing function of the dividend growth rate (g)

d. II When g exceeds r then the stock’s intrinsic value is negative, meaning the stock is worthless

e. II and III are correct

Explanation / Answer

The dividend growth model equates a stock’s intrinsic value (theoretical price) to the discounted sum of the constant growth dividend stream. The relationship between the dividend growth rate (g) and the discount rate (r) is very important. Which statement accurately describes that relationship?

c. III The stock’s intrinsic value is an increasing function of the dividend growth rate (g)

Note :

As per DDM

stock’s intrinsic value= D1/(r-g)

As per this model  stock’s intrinsic value increases at the dividend growth rate

if g exceeds r then the stock’s intrinsic value is infinite

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