The Dividend Discount Model - Understanding its Assumptions and Applications

The Dividend Discount Model

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Question

The Dividend Discount Model:

I. is primarily used to price mature stocks.

II. assumes constant dividends.

III. assumes a constant dividend payout ratio.

IV. works only if the growth rate is higher than the expected rate of return.

Answers

Explanations

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A. B. C. D. E. F. G.

C

Dividend Discount Model assumes a constant growth in dividends but does not require the payout ratio to be constant. Also, it is applicable only when the constant growth rate is lower than the expected rate of return (It does not preclude the growth rate from exceeding the expected rate of return over some periods. However, in that case, the formula that arises from the assumption of constant growth rate cannot be used).

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