According to the Dividend Discount Model (DDM) which of the following would NOT increase the share price of a stock?Group of answer choicesAn increase in the discount rateA decrease in the discount rateAn increase in the growth rateAn increase in next period's dividend
Question
According to the Dividend Discount Model (DDM) which of the following would NOT increase the share price of a stock?Group of answer choicesAn increase in the discount rateA decrease in the discount rateAn increase in the growth rateAn increase in next period's dividend
Solution
According to the Dividend Discount Model (DDM), an increase in the discount rate would NOT increase the share price of a stock.
Here's why:
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The Dividend Discount Model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.
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The formula for DDM is: P = D1 / (r - g) where: P = price of the stock today D1 = dividend expected to be received in the next period r = required rate of return (or discount rate) g = growth rate in dividends
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According to this formula, the stock price (P) is inversely related to the discount rate (r). This means that if the discount rate increases, the denominator of the equation becomes larger, and thus the stock price decreases.
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On the other hand, an increase in the growth rate (g) or next period's dividend (D1) would increase the stock price, as they would increase the numerator or decrease the denominator of the equation, respectively.
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Therefore, an increase in the discount rate would NOT increase the share price of a stock.
Similar Questions
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