 The simple dividend discount model is not useful in valuing any company's stock because it requires yearly dividend forecasts for an indefinite future. So in order to make this dividend discount model practical, some assumptions are required to be taken. The first assumption is that the dividend discount model assumes an upward trend in dividend at a stable growth rate and that growth rate is termed as G. This means that intrinsic value or the P0 of a V0 of a stock is then equal to the present value of dividends and those dividends that are grown at a specific growth rate. This means that for each year we need to grow the dividend of that particular at a stable growth rate. This means that in that case the present value or V0 of the particular stock is equal to some grown dividend at the capitalized rate. In simple V0 is equal to the D1 divided by K minus G and here D1 is basically the D0 multiplied by the growth rate and K is the required rate of return or the capitalization rate and G is the dividend growth rate and this equation says that it generalizes the perpetuity formula of growing perpetuity. The rise in G for a given value of D1 stock price also rises so the implication of this model is that if the value of G increases the value of stock increases. We see that dividend stream not growing. If this is the case then we see we will call these dividend stream as a perpetuity cash flows and in that particular case to determine the intrinsic value or V0 which will simply divide the D1 over the capitalization rate the formula will come to D1 divided by K. Now this specific dividend discount model works let's see we have preferred stock valuation through the dividend discount model. We have fixed dividend of $2 per share we have discount rate of 8 percent now to determine the V0 of this stock we simply divide the dividend per share of $2 over the capitalization rate which is 8 percent and we see that in our example G is zero so the answer comes to $25 per share and that is the V0 of this particular preferred stock. In this stream we see our dividends as a perpetuity cash flow. The second we have constant growth model for common stock in this model example we see annual dividend $3 per share dividend expected growth rate 8 percent the company's stock beta 1 risk pre rate 6 percent market risk premium 8 percent now to determine the share value or V0 we will be using the dividend discount model and that is D1 over K minus G we have D1 equal to 3 into 1.08 and to determine the required rate of return we have our values that will be using through CAPM and we have growth rate of 8 percent the resulting value of V0 comes to $54 so this is the intrinsic value of this particular stock we see that the stocks perceived to be riskier must have a lower value this mean that if the stock is more risky the required return on this particular stock will go higher and as a result the price of the stock will go down or we have a lower V0 or intrinsic value now let's see how this applies we have an example we have revised beta in our earlier illustration of 1.25 we have to determine share value or V0 which is again we will be using the formula of D1 over K minus G D1 we have the same as we have seen in our earlier example we have one change with reference to K and that is the change of beta which is increased from 1 to 1.25 so new value is 1.25 there is an increase of 0.25 in our beta so the riskiness of our firm has been increased now the answer of this value this model is $40 so when the beta of the firm was 1 its V0 was equal to $54 the beta has been increased from 1 to 1.25 the value has been decreased from $54 to $40 so there has been a decline in the value of this particular stock by $14 now we see that this particular model that is known as constant dividend discount model constant growth dividend discount model that is valued only when G is less than K if G is greater than K we have an infinity value as our solution G is less than K the growth rate must be unsustainable in the long run because we cannot have our K lesser than the growth rate the stock price is expected to grow at the same rate as dividend and the implication of this assumption is that the how much increase in the dividend growth rate that will be accordingly shown in the stock price of the stock see what is the implication of constant growth dividend discount model and this constant growth dividend discount model is also known as the Gordon model because it has been given by the Gordon the first implication is that the higher the stock value if it has larger expected dividend per share lower market capitalization rate or K higher expected dividend growth rate this means that if we have higher value of D1 if we have lower value of K and higher value of G the V0 or the intrinsic value of the stock will go high this constant growth dividend discount growth rate will observe price appreciation in any year at the same rate as we have earlier seen that the growth rate increment will be accompanied by the increments in the stock price for a stock price whose market value or P0 is equal to its intrinsic value or V0 the expected return will be equal to dividend yield plus the capital gain and dividend yield is equal to D1 over P0 whereas capital gain is the difference between P1 and P0 and that difference is to be divided by the P0 so we will be having capital gain yield in other words in other words the expected return in this particular case is equal to D1 plus P0 plus D1 over P0 plus G which is the gain yield and when P0 is equal to V0 then the expected return will be equal to the K or the capitalization rate and this will be equal to dividend or D1 over P0 plus G so we can also say that this particular formula is also considered as the discounted cash flow formula because in this formula the variable K acts as a factor that discounts the cash flows of yearly dividends. What is the effect of a news on the intrinsic value of a stock we have an example here a news reflected in stock prices its expected return will be in line with the risk of the stock so with the inception of any news in the market the associated risk will be reflected in the expected return of that particular stock we have a comparative data here in terms of old values and new values our current dividend is 3.81 and expected is $4 our expected dividend growth rate is 5% and 6% our capitalization rate is the same at 12% now what is the effect of this news on the stock prices or the intrinsic value we will be using the constant growth dividend discount model which is D0 or D1 plus G D1 D1 over K minus G if we see the value of this stock in terms of old values we have 57.14 whereas the new value is 66.67 this means that this news has increased some riskiness for this particular stock and that has increased the intrinsic value of the stock now what is the effect on the expected rate of return for determining expected rate of return we are using the formula of D1 over P0 plus capital gain yield and we have the similar value for the two scenarios and that value is 12% now we see that the P0 or the V0 raises as the higher D1 and the G so D1 and G grows higher P0 will grow higher and we also see that there is no change in the risk so there is no change in the expected rate of return