Canadian Securities Course (CSC) Level 2 Practice Exam

What does the dividend discount model (Gordon Growth Model) focus on in company valuation?

1. Assessing short-term market fluctuations

2. Evaluating historical dividend payments only

3. Determining the present value of the expected future dividends

4. Projected annual revenue growth

The correct answer is: Determining the present value of the expected future dividends

The dividend discount model, commonly referred to as the Gordon Growth Model, is centered around determining the present value of expected future dividends. This approach is rooted in the concept that the value of a stock is essentially the present worth of all its future dividend payments. By discounting these future dividends back to their present value, investors can assess what they should be willing to pay for a share of stock today based on the income it is expected to generate over time. This model assumes that dividends will grow at a constant rate indefinitely, which allows investors to make informed decisions regarding the valuation of a company based on its potential to provide income through dividends. The emphasis on future dividend cash flows sets it apart from methods that focus on other aspects of a company's performance, such as revenue growth or short-term market movements.