Question

Based on the dividend discount model, an increase in which of the following will lower the current value of a stock?
I. amount of the next dividend
II. dividend growth rate
III. discount rate
A. I only
B. III only
C. I and II only
D. II and III only
E. I, II, and III
See Section 6.2
Answer: B. III only

Answer 1

Based on the dividend discount model, an increase in discount rate will lower the current value of a stock.

What is Dividend Discount Model?

The dividend discount model (DDM) is a quantitative technique for forecasting the price of a company's stock based on the idea that, when discounted back to their present value, all of the company's future dividend payments are worth the present price of the stock. It considers the dividend distribution criteria and the market expected returns in an effort to determine the fair value of a company regardless of the current market conditions. The stock is cheap and is a candidate for a buy if the value derived from the DDM is greater than the current trading price of shares, and vice versa.

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