In the context of the two-stage dividend growth model, what happens if the assumption that dividends drop immediately from a high growth rate to a perpetual growth rate is violated?

If the assumption that dividends drop immediately from a high growth rate to a perpetual growth rate is violated, it can lead to inaccuracies in stock valuation. The model may not accurately reflect the true growth trajectory of dividends, potentially resulting in an incorrect stock price. Analysts may need to use alternative methods, such as linear interpolation, to better estimate dividend growth over time.

When the assumption of an immediate drop from a high growth rate to a perpetual growth rate is not met, the two-stage dividend growth model may yield misleading results. This is because the model simplifies the transition between growth phases, and any deviation from this assumption could distort the valuation. In practice, analysts often refine their estimates by applying linear interpolation, gradually decreasing the growth rate instead of making an abrupt change, which provides a more realistic projection of future dividends and stock prices.