What assumption does the Dividend Growth Model make about dividends?

• A. Dividends will grow at a constant rate.
• B. Dividends will cease after a finite period.
• C. Dividends are fixed and do not change.
• D. Dividends are independent of growth.

Answer: (A)

The Dividend Growth Model assumes that dividends grow at a constant rate forever. This steady, perpetual growth is what makes the model tractable: the price today is the present value of an infinite sequence of dividends that rise by a fixed percentage each year, which leads to the familiar formula P0 = D1 / (r − g) where D1 is the next year's dividend and r is the required return. A crucial condition is that r must exceed the growth rate g; otherwise the value would be undefined. Because the model hinges on dividends growing at a constant rate indefinitely, statements about dividends ceasing after a finite period, remaining fixed with no growth, or being independent of growth don’t fit the framework.