5. Expected returns, dividends, and growth

The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows:

P0P0

=

D1(rs gL)/rs gL

If you were analyzing the consumer goods industry, for which kind of company in the industry would the constant growth model work best?

A. Young companies with unpredictable earnings

B. Mature companies with relatively predictable earnings

C. All companies

Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $2.25 at the end of the year. Its dividend is expected to grow at a constant rate of 6.00% per year. If Walters stock currently trades for $19.00 per share, what is the expected rate of return?

A. 14.24%

B. 17.84%

C. 6.83%

D. 6.11%

Which of the following statements will always hold true?

A. The constant growth valuation formula is not appropriate to use unless the companys growth rate is expected to remain constant in the future.

B. It will never be appropriate for a rapidly growing startup company that pays no dividends at presentbut is expected to pay dividends at some point in the futureto use the constant growth valuation formula.

C. The constant growth valuation formula is not appropriate to use for zero growth stocks.