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Expected returns, dividends, and growth

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The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows:

Which of the following statements is true?

Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth.

Increasing dividends will always increase the stock price.

Increasing dividends will always decrease the stock price, because the firm is depleting internal funding resources.

Points:

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Explanation:

Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $2.85 at the end of the year. Its dividend is expected to grow at a constant rate of 6.00% per year. If Walter’s stock currently trades for $25.00 per share, then the expected rate of return on the stock is selector 1

12.18%

22.62%

14.79%

17.40%

Points:

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Explanation:

Which of the following statements will always hold true?

The constant growth valuation formula is not appropriate to use for zero growth stocks.

It will never be appropriate for a rapidly growing startup company that pays no dividends at present—but is expected to pay dividends at some point in the future—to use the constant growth valuation formula.

The constant growth valuation formula is not appropriate to use unless the company’s growth rate is expected to remain constant in the future.

Explanation / Answer

1)correct option is "A" -Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth

2)Expected rate = (D1/Price)+g

                    = (2.85 /25) + 0.06

                     = .114+.06

                     = .174 or 17.4%

correct option is " 4"

3)The constant growth valuation formula is not appropriate to use unless the company’s growth rate is expected to remain constant in the future.

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