The constant dividend growth model is useful to corporate ma

The constant dividend growth model is useful to corporate managers because it points out that stock price is related most closely to three factors, state what these three factors are? Choose any of the three factors stated above and state what underlying firm characteristic it is related to

Solution

As per the Constant Dividend Growth Model, the price of share is given by the formula: P0 = D1/(r-g) where P0 = Current price D1 = Next expected dividend r = The required rate of return for the stock g = Expected growth rate of dividends Therefore, the three factors are: The next expected dividend, the required rate of return for the stock and the divdend growth rate. Factor chosen--the growth rate of dividends. It is given by the product of ROE*Retention ratio. Hence, it is related to the firms dividend policy and its earning capacity in terms of ROE.