CAF-7 · Chapter 9 · Question 14 of 15
A company uses the Dividend Valuation Model to value its equity. What happens mathematically to the model if the assumed dividend growth rate (g) is equal to or higher than the investors' required rate of return (Ke)?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) The model becomes mathematically invalid as the denominator becomes zero or negative
Explanation
In the formula Po = D1 / (Ke - g), if g is equal to or greater than Ke, the denominator becomes zero or negative, yielding an infinite or negative stock price. The model assumes Ke must always be strictly greater than g.
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