Which of the following statements is CORRECT?

a. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
b. If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
c. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.
d. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.
e. The stock valuation model, P0 = D1/(rs - g), can be used to value firms whose dividends are expected to decline at a constant rate, i. e., to grow at a negative rate.

D. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.

Explanation:

So, we evaluate each option.

a. We discount the dividends by the required rate of return. So incorrect.

b. The dividend yield is annual dividend per share divided by stick price per share. the 5% is the growth in dividend and not the actual dividend itself. So, incorrect.

c. The constant growth is appropriate for companies whose dividend patterns are stable. Startups have multiple stage growths and this option becomes incorrect as constant growth is not applicable.

d. A zero growth stock is one where dividend remains the same. So when there is no growth in dividend, the constant growth model becomes inapplicable. So, the statement is correct.

So, here we have our correct statement and all others are incorrect.

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