The cost of capital for common stock is ke=(d1/Po)+g. What are the assumptions of the model?
A. growth (g) is constant to infinity
B. The price earnings ration stay the same
C. The firm must pay a dividend to use this model
D All of the above are assumptions of the model
I rean in the tex book ... for a constant growth stock, the following conditions must hold:
1. the expected dividend yield is constant
2. the dividend is expected to grow forever at a constant rate.
that means that D is the correct answer, because the company must pay a dividend to make all of these things happen.
Is that correct???
Yes, your understanding is correct. The assumptions of the constant growth model for common stock include:
1. Growth (g) is constant to infinity: This assumes that the dividend growth rate remains constant indefinitely. It assumes that the company will continue to grow at a consistent rate in perpetuity.
2. The price-earnings ratio stays the same: This assumption assumes that the market value of the stock relative to its earnings remains constant. It implies that investors' expectations about the company's future performance and growth prospects do not change.
3. The firm must pay a dividend to use this model: This assumption assumes that the company pays dividends to its shareholders. Dividends are a crucial component in the model as they are used to calculate the expected dividend yield (d1/Po).
Therefore, from your understanding, all of the options A, B, and C are correct assumptions of the model, making option D the correct answer.