Infinite Period Dividend Discount Model: CFA Level 1 Exam - Test Prep

The Infinite Period Dividend Discount Model

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Question

The infinite period dividend discount model assumes that

Answers

A. dividends grow at a constant rate, that constant rate will continue for an infinite period of time, and that the required rate of return on the stock is greater than the growth rate. Making these assumptions, the model states that the value of a stock is equal to the current dividend payment divided by the spread between the required rate of return and the growth rate of dividends.

B. dividends grow at a constant or increasing rate, and that the required rate of return on the stock is greater than the growth rate. Making these assumptions, the model states that the value of a stock is equal to the dividend payout ratio divided by the spread between the required rate of return and the growth rate of dividends.

C. dividends grow at a constant or increasing rate, and that the growth rate of dividends is higher than the required rate of return on the stock. Making these assumptions, the model states that the valueof a stock is equal to the dividend payout ratio divided by the spread between the required rate of return and the growth rate of dividends.

D. dividends grow at a constant rate, and that constant rate will continue for an infinite period of time. Making these assumptions, the model states that the value of a stock is equal to the dividend payout ratio divided by the spread between the required rate of return and the growth rate of dividends.

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Explanations

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A. B. C. D.

The dividend discount model's fundamental assumption is that the value of a share of common stock is equal to the present value of all future dividends. The assumption that a firm's dividends grow at a constant rate for an infinite period of time is seldom true for companies growing at above-average rates. For example, although Intel and Wal-Mart have both grown at rates in excess of 30% a year for several years, it is doubtful that they will be able to maintain such high growth for an infinite period.

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