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Stocks A and B have the following data. The market risk premium is 6.0% and the...

Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Beta 1.10 0.90 Constant growth rate 7.00% 7.00% a. Stock B could have the higher expected return. b. Stock A must have a higher dividend yield than Stock B. c. Stock B's dividend yield equals its expected dividend growth rate. d. Stock B must have the higher required return. e. Stock A must have a higher stock price than Stock B.

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Answer #1

Answer:

Stock A:
Cost of Equity = Risk Free Rate + Beta * Market Risk Premium
Cost of Equity = 6.40% + 1.10 * 6.00%
Cost of Equity = 13.00%

Dividend Yield = Cost of Equity – Growth Rate
Dividend Yield = 13.00% - 7.00%
Dividend Yield = 6.00%

Stock B:
Cost of Equity = Risk Free Rate + Beta * Market Risk Premium
Cost of Equity = 6.40% + 0.90 * 6.00%
Cost of Equity = 11.80%

Dividend Yield = Cost of Equity – Growth Rate
Dividend Yield = 11.80% - 7.00%
Dividend Yield = 4.80%

Therefore, Option b i.e. Stock A must have a higher dividend yield than Stock B.

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