What does the equation D(1+g)/(r-g) represent in finance?

The equation D(1+g)/(r-g) represents the formula for valuing a constant growth dividend stock, known as the Gordon Growth Model or Dividend Discount Model (DDM). In this formula, D refers to the expected dividend next year, g represents the constant growth rate of the dividends, and r signifies the required rate of return or discount rate.

This model assumes that dividends will increase at a constant rate indefinitely, allowing investors to determine the present value of all future dividend payments. By using future dividends that grow at a specific rate, the equation helps to establish a fair value for a stock based on its expected future cash flows. If the required rate of return exceeds the growth rate, the model can successfully yield a finite valuation; however, if the growth rate were equal to or exceeded the required return, it would create an infinite or undefined scenario.

The other options address different concepts in finance. For instance, the calculation for a zero growth stock value does not involve a growth component, estimating firm risk is unrelated to dividend valuation, and calculating total return encompasses more than just the present value of future dividends, including factors like capital gains. Thus, this equation is specifically tailored to value a stock with dividends expected to grow at a constant rate.