ACCA Financial Management (F9) Certification Practice Exam

According to the Dividend Valuation Model, what primarily determines the equilibrium price of a share?

1. The company's current asset value

2. The expected future stream of income from the security

3. The past performance of the stock

4. The total earnings of the company

The correct answer is: The expected future stream of income from the security

The Dividend Valuation Model, also known as the Gordon Growth Model, centers around the concept that the value of a stock is determined primarily by the present value of its expected future dividends. Therefore, the expected future stream of income from the security is critical in determining the equilibrium price of a share. This model assumes that dividends will grow at a constant rate, and investors are willing to pay a price for a share based on these anticipated cash flows. The model suggests that investors discount these future dividends back to their present value to decide how much they should pay for the stock today. Essentially, it emphasizes the importance of future income rather than past performance or current asset values in deciding a stock's current worth. Factors such as past performance or total earnings of the company may influence investor perceptions or market sentiment, but they are not the primary determinants according to the Dividend Valuation Model. Current asset values are also not a reflection of the future income stream that investors look for when valuing shares. Thus, the focus on expected future income makes it the critical determinant in this model.