What assumption is commonly made about growth rates in the Gordon growth model?

What assumption is commonly made about growth rates in the Gordon growth model?

• A. They are dynamic and change annually
• B. They should be negative after a certain period
• C. They should be constant over an indefinite horizon
• D. They must always increase

Answer: (C)

The Gordon growth model, also known as the Dividend Discount Model (DDM), is based on the assumption that a company's dividends will grow at a constant rate indefinitely. This assumption simplifies the valuation process, allowing analysts to determine the present value of a stock based on the expected future dividends, which grow at this consistent rate. The rationale behind this assumption is that in mature companies or industries, dividend growth may stabilize over time due to established market conditions and competitive advantages. By assuming a constant growth rate, the model can be used to derive a straightforward formula for calculating the present value of a stock, thereby facilitating investment decisions. While it's theoretically possible for dividends to be dynamic or to change annually, such variability can complicate the analysis and is not consistent with the fundamental premise of the Gordon growth model. Similarly, the notion that growth rates must always be positive or increase is too restrictive and doesn't accurately reflect the realities of business cycles, where periods of decline can occur. Hence, the focus on a constant growth rate over an indefinite horizon is a central tenet of the model.

The Gordon growth model, also known as the Dividend Discount Model (DDM), is based on the assumption that a company's dividends will grow at a constant rate indefinitely. This assumption simplifies the valuation process, allowing analysts to determine the present value of a stock based on the expected future dividends, which grow at this consistent rate.

The rationale behind this assumption is that in mature companies or industries, dividend growth may stabilize over time due to established market conditions and competitive advantages. By assuming a constant growth rate, the model can be used to derive a straightforward formula for calculating the present value of a stock, thereby facilitating investment decisions.

While it's theoretically possible for dividends to be dynamic or to change annually, such variability can complicate the analysis and is not consistent with the fundamental premise of the Gordon growth model. Similarly, the notion that growth rates must always be positive or increase is too restrictive and doesn't accurately reflect the realities of business cycles, where periods of decline can occur. Hence, the focus on a constant growth rate over an indefinite horizon is a central tenet of the model.