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?

Price A. 25 B. 25

Expected growth (constant) A. 10% B. 5%

Required Return A. 15% B. 15%

a. Stock A's expected dividend at t = 1 is only half that of Stock B.

b. Stock A has a higher dividend yield than Stock B.

c. Currently the two stocks have the same price, but over time Stock B's price will pass that of A.

d. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high as Stock B’s.

e. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.

Answer 1

Solution :-

Stock A

Price ( P ) = $25

Required Return ( ke ) = 15%

Growth Rate ( g ) = 10%

Now Price = D1 / ( ke - g )

= $25 = D1 / ( 15% - 10% )

D1 = $1.25

Now D1 of Stock A = $1.25

Stock B

Price ( P ) = $25

Required Return ( ke ) = 15%

Growth Rate ( g ) = 5%

Now Price = D1 / ( ke - g )

= $25 = D1 / ( 15% - 5% )

D1 = $2.50

Now D1 of Stock B = $2.50

Therefore Correct Answer is ( A ) that is Stock A's expected dividend at t = 1 is only half that of Stock B.

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