Certified Management Accountant Practice Exam 2025 – The Comprehensive All-in-One Guide to Exam Success!

The correct answer is based on the principles of the Dividend Growth Model (DGM), which is a way to value a stock by assuming that dividends will continue to grow at a constant rate. The formula used in this model for determining the current market value of a stock is derived from the expected future growth of dividends.

This formula essentially states that the current market value of a stock is equal to the next expected dividend divided by the difference between the required rate of return and the dividend growth rate. The rationale behind the formula is that investors will only invest in a stock if the expected return compensates for the risk taken, which is represented by the required rate of return. The dividend growth rate reflects the company’s anticipated ability to increase its dividend payouts over time, which is a significant factor for many investors in their valuation process.

Understanding this, one can see how if the required rate of return is less than the growth rate, the denominator would result in a negative value, leading to an implausible infinite value for the stock. Consequently, this reflects a crucial aspect of the model—the assumption that the required rate of return must always be greater than the dividend growth rate for the formula to hold. This dynamic highlights the importance of both the expected growth in dividends