Question

The required returns of Stocks X and Y are r_X = 10% and r_Y = 12%. Which of the following statements is CORRECT?

a. If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.

b. Stock Y must have a higher dividend yield than Stock X.

c. The stocks must sell for the same price.

d. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

e. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.

Answer 1

The required rate on a stock is equal to

Required rate = dividend yield + growth rate

Dividend yield = required rate – growth rate

The correct answer is

if the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

Stock X

Dividend yield = 10% - growth rate

Stock Y

Dividend Yield = 12% - growth rate

Other options are not correct. Then the stock does not need to sell at the same price and nor it is necessary that stock Y has higher dividend yield. If stock Y and stock X have the same dividend yield then stock Y would have higher growth rate than the stock X not lower.