The constant-growth dividend discount model would typically be most appropriate in valuing a stock of a:
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A) |
new venture expected to retain all earnings for several years. |
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B) |
company with valuable assets not yet generating profits. |
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C) |
moderate growth, "mature" company. |
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D) |
rapidly growing company. |
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The correct answer was C) moderate growth, "mature" company.
Remember, the infinite period DDM has the following assumptions:
§ The stock pays dividends and they grow at a constant rate.
§ The constant growth rate, g, continues for an infinite period.
§ k must be greater than g. If not, the math will not work.
If any one of these assumptions is not met, the model breaks down. The infinite period DDM doesn’t work with growth companies. Growth companies are firms that currently have the ability to earn rates of return on investments that are currently above their required rates of return. The infinite period DDM assumes the dividend stream grows at a constant rate forever while growth companies have high growth rates in the early years that level out at some future time. The high early or supernormal growth rates will also generally exceed the required rate of return. Since the assumptions (constant g and k>g) don’t hold, the infinite period DDM cannot be used to value growth companies. | 
发表于 2006-4-27 14:58
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