Question

Stocks A and B have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

	Stock A	Stock B
Required return	12%	15%
Market price	$30	$45
Expected constant growth rate of dividends	8%	8%

		These two stocks should have the same price.
		These two stocks must have the same dividend yield.
		These two stocks should have the same expected return.
		These two stocks must have the same expected capital gains yield.
		These two stocks must have the same expected year-end dividend.

Answer 1

Given about stock A,

Required return rs = 12%

Market price = $30

Growth rate g = 8%

So, using this,

dividend yield = rs - g = 12-8 = 4%

Capital gains yield = g = 8%

year end dividend D1 = P0*(rs-g) = 30*(0.04) = $1.2

For stock B,

Required return rs = 15%

Market price = $45

Growth rate g = 8%

So, using this,

dividend yield = rs - g = 15-8 = 7%

Capital gains yield = g = 8%

year end dividend D1 = P0*(rs-g) = 45*(0.07) = $3.15

So, for both the stock, only Capital gains yield is same.

Option D is correct.