week 5

Question 1

What is the basic principle behind stock valuation models?

Answer 1

Stock value equals the present value of all expected future dividends, reflecting the income an investor expects to receive.

Question 2

What is the Simple Dividend Discount Model (Perpetuity, No Growth)?

Answer 2

P0 = D / i, where D is dividend per period and i is the required rate of return; assumes dividends are constant forever.

Question 3

What is the Constant Growth Dividend Discount Model (Gordon Growth Model)?

Answer 3

P0 = D1 / (i - g), where D1 is next period’s dividend, i is required return, and g is dividend growth rate. Assumes dividends grow at a constant rate.

Question 4

How does the Variable Growth Dividend Discount Model work?

Answer 4

Calculates present value of dividends with varying growth rates in early years, then applies a constant growth model after year n, discounting all back to present.

Question 5

How do you value a stock with changing dividend growth rates?

Answer 5

Use a multi-stage DDM summing discounted dividends during high-growth phase plus discounted terminal value at stable growth phase.

Question 6

Why is the required rate of return important in stock valuation?

Answer 6

It reflects the investor’s risk tolerance and opportunity cost, used to discount future dividends to present value.

Question 7

What impact does dividend growth rate have on stock price in DDM?

Answer 7

Higher dividend growth increases stock value since expected future dividends are larger.