b) The dividend growth model (DGM) is used widely in valuing ordinary shares and
hence in valuing companies, but there are a number of weaknesses associated with
its use.

• The future dividend growth rate
  The DGM is based on the assumption that the future dividend growth rate is
  constant, but experience shows that a constant dividend growth rate is, in reality,
  very rare. This may be seen as less of a problem if the future dividend growth rate
  is regarded as an average growth rate. Estimating the future dividend growth rate
  is very difficult in practice and the DGM is very sensitive to small changes in this
  key variable. It is common practice to estimate the future dividend growth rate by
  calculating the historical dividend growth, but the assumption that the future will
  reflect the past is an easy one to challenge.
•  The cost of equity
  The DGM assumes that the future cost of equity is constant, when in reality it
  changes quite frequently. The cost of equity can be calculated using the capital
  asset pricing model, but this model usually employs historical information, which
  may not reflect accurately expectations about the future.
•  Zero dividends
  It is sometimes claimed that the DGM cannot be used when no dividends are paid,
  but this depends on whether dividends are expected in the future. If dividends are
  forecast to be paid from a future date, the dividend growth model can be applied
  at that point to calculate a share price, which can then be discounted to give the
  current ex dividend share price. Only in the case where no dividends are paid and
  no dividends are expected to be paid will the DGM have no application.

(3 points well explained @ 2 marks each = 6 marks)