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 Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X. B) 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. C) The stocks must sell for the same price. D) Stock Y must have a higher dividend yield than Stock X. E) 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.

Question

Quizplus · Accepted Answer

Given that Stock Y has a higher required return (12%) compared to Stock X (10%), if Stock Y has a lower dividend yield than Stock X, for the market to be in equilibrium (meaning investors are compensated for the risk they take), Stock Y must offer a higher expected growth rate in dividends. This is because the total return on a stock comes from the dividend yield plus the capital gains yield (growth in the price of the stock, which is often related to the growth in dividends).

The Required Returns of Stocks X and Y Are RX

The Required Returns of Stocks X and Y Are R_X