Dividend Constant-Growth Model

Question

Investors expect the following series of dividends from a particular ordinary share:

Year 1 $1.10

Year 2 $1.25

Year 3 $1.45

Year 4 $1.60

Year 5 $1.75

After the fifth year, dividends will grow at a constant rate. If the required rate of return on this equity is 9% and the current market price is $45.64.

In the dividend constant-growth model we can apply the equation that P=D/(r-g) only under the assumption that r>g. Suppose someone tries to argue with you that for a certain share, r < g forever, not just during a temporary growth spurt. Why can’t this be the case? What would happen to the share price if this were true? If you try to answer simply by looking at the formula you will almost certainly get the wrong answer. Think it through.

Summary

The question belongs to Finance and it discusses about dividend constant-growth model in share valuation.

Total Word Count 97