Question

5. The constant perpetual growth model is applicable primarily to those firms which: A. adhere to a residual dividend policy.
B. pay dividends that increase at a steady rate.
C. have irregular dividend growth rates.

D. maintain a constant dividend payout ratio. E. have multiple rates of dividend growth.

6. The arithmetic average dividend growth rate is:
A. the compounded rate of growth over a specified time period.
B. easier to compute than the geometric average dividend growth rate.
C. the summation of the annual dividend growth rates.
D. generally preferred over the geometric average growth rate by most financial analysts.
E. generally larger than the geometric average growth rate when the annual growth rates are positive.

Answer 1

5. B. In case of such firms, we use Gordon Growth Model which assumes that the growth rate will be less than the discount rate.

6. E. This can be better understood with the help of an example.

Assuming growth rate of dividends are 10%,20%,30%,40% and 50% in five years:

Arithmetic average growth=(10+20+30+40+50)/5=30%

Geometric average growth=(1.1*1.2*1.3*1.4*1.5)^1/5-1

=(2.4024)^1/5-1

=1.19159607-1

=0.19159607 that is 19.16%.