17 Lecture

1. The common stock pricing and dividend growth model is used to estimate the fair value of a stock based on: a) Its historical dividend payments b) Its expected future dividend payments c) Its stock price at a given point in time d) Its industry average P/E ratio

Answer: b) Its expected future dividend payments

2. According to the dividend growth model, the value of a stock is equal to: a) Its current stock price b) The sum of its historical dividend payments c) The sum of its expected future dividend payments d) Its book value

Answer: c) The sum of its expected future dividend payments

3. The discount rate used in the dividend growth model is typically: a) The risk-free rate of return b) The company's cost of equity c) The industry average P/E ratio d) The company's debt-to-equity ratio

Answer: b) The company's cost of equity

4. If a company's dividend growth rate is expected to be 5% per year and its current annual dividend is $2 per share, what is the expected dividend per share in 5 years? a) $2.63 b) $2.78 c) $3.10 d) $3.24

Answer: c) $3.10

5. The dividend growth model assumes that the company's dividend growth rate will: a) Increase over time b) Remain constant over time c) Decrease over time d) Fluctuate randomly over time

Answer: b) Remain constant over time

6. The dividend growth model can be used to estimate the fair value of: a) Growth stocks b) Value stocks c) Income stocks d) All of the above

Answer: c) Income stocks

7. If a company has a current stock price of $50 and an expected annual dividend of $2 per share, what is the expected dividend yield? a) 2% b) 4% c) 5% d) 10%

Answer: b) 4%

8. The dividend growth model assumes that investors require a higher return on their investment as: a) The dividend growth rate increases b) The dividend growth rate decreases c) The discount rate increases d) The discount rate decreases

Answer: c) The discount rate increases

9. If a company's cost of equity is 10% and its expected dividend growth rate is 5%, what is the expected dividend yield? a) 5% b) 10% c) 15% d) 20%

Answer: a) 5%

10. The dividend growth model assumes that a company's future dividend payments are: a) Guaranteed to occur b) Not guaranteed to occur c) Guaranteed to increase over time d) Not guaranteed to increase over time

Answer: b) Not guaranteed to occur

1. What is the dividend growth model? Answer: The dividend growth model is a method used to estimate the fair value of a stock based on its expected future dividend payments, which are discounted to their present value using an appropriate discount rate.

2. What is the formula for the dividend growth model? Answer: The formula for the dividend growth model is V0 = D1 / (ke - g), where V0 is the current value of the stock, D1 is the expected dividend payment one year from now, ke is the company's cost of equity, and g is the expected dividend growth rate.

3. How does the dividend growth model help investors evaluate stocks? Answer: The dividend growth model helps investors evaluate stocks by estimating their fair value based on the expected future cash flows from dividend payments.

4. What are the limitations of the dividend growth model? Answer: The limitations of the dividend growth model include its reliance on assumptions about the stability of dividend growth rates and the discount rate used, and its inability to account for non-dividend cash flows.

5. What is the relationship between a company's dividend yield and its stock price? Answer: The dividend yield and stock price have an inverse relationship, meaning that as the stock price increases, the dividend yield decreases, and vice versa.

6. How does a company's cost of equity impact its stock valuation using the dividend growth model? Answer: The cost of equity is used as the discount rate in the dividend growth model, so an increase in the cost of equity will result in a lower stock valuation, and vice versa.

7. What is the difference between a constant growth and non-constant growth dividend model? Answer: A constant growth dividend model assumes a steady and predictable dividend growth rate, while a non-constant growth model allows for fluctuating dividend growth rates.

8. How can a company's historical dividend payments be used in the dividend growth model? Answer: A company's historical dividend payments can provide insights into its past dividend growth rates and help investors make assumptions about its future dividend growth potential.

9. How does the dividend growth model relate to the concept of intrinsic value? Answer: The dividend growth model is used to estimate the intrinsic value of a stock based on its expected future cash flows, which is the theoretical value of a stock that represents its true worth.

10. What are the advantages of using the dividend growth model in stock valuation? Answer: The advantages of using the dividend growth model include its simplicity, transparency, and ability to focus on a company's fundamental value drivers.

Common stock pricing is a fundamental aspect of stock valuation that involves estimating the fair value of a stock. One commonly used approach to common stock pricing is the dividend growth model. This model assumes that the value of a stock is equal to the present value of its expected future dividend payments, discounted by an appropriate discount rate. The formula for the dividend growth model is V0 = D1 / (ke - g), where V0 is the current value of the stock, D1 is the expected dividend payment one year from now, ke is the company's cost of equity, and g is the expected dividend growth rate. The dividend growth model assumes that the company will continue to pay dividends at a steady and predictable rate, and that the dividend growth rate will remain constant over time. In reality, however, dividend growth rates can fluctuate based on a variety of factors such as changes in market conditions, company performance, and economic trends. To account for this variability, the dividend growth model can be modified to include a non-constant growth rate, which allows for fluctuating dividend growth rates over time. This can be particularly useful for companies that are experiencing changes in their industry or business model, and may be more appropriate for companies with high growth potential. The dividend growth model also assumes that the cost of equity, or the required return on investment, will remain constant over time. However, the cost of equity can fluctuate based on changes in market conditions and the company's perceived risk. A higher cost of equity will result in a lower stock valuation, and vice versa. When using the dividend growth model, it is important to consider its limitations. The model relies on assumptions about the stability of dividend growth rates and the discount rate used, and does not account for non-dividend cash flows. As such, it should be used in conjunction with other valuation methods and financial analysis. Overall, the dividend growth model is a useful tool for estimating the intrinsic value of a stock based on its expected future cash flows from dividend payments. However, it should be used in conjunction with other valuation methods and financial analysis to arrive at a comprehensive and accurate stock valuation.