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?
$\begin{array}{lcc}
& \mathrm{A}& \underline{\mathrm{B}}\
\text { Beta } &1.10&0.90\
\text { Constant growth rate } & 7.00 \% & 7.00 \%
\end{array}$
A) stock a must have a higher dividend yield than stock b.
B) stock b's dividend yield equals its expected dividend growth rate.
C) stock b must have the higher required return.
D) stock b could have the higher expected return.
E) stock a must have a higher stock price than stock b.

Question

Quizplus · Accepted Answer

Statement a is true, because Stock A has a higher required return but the stocks have the same growth rate, so Stock A must have the higher dividend yield. Here are some calculations to demonstrate the point.
 $\begin{array}{cccccccc} 
&\text { r}_{RF} && \text { beta } & & \text { RP}_{M} & & \text { rStock } \
\hline  \mathrm{A} & 6.40 \% & + & 1.10 & \times & 6.00 \% & = & 13.00 \% \
\mathrm{~B} & 6.40 \% & + & 0.90 & \times & 6.00 \% & = & 11.80 \%\
\hline 
\end{array}$
$\begin{array}{ccccc}
&\text { Div. Yld. } & & g & & r_{\text {Stock }} \
\hline A&\mathrm{D}_{1} / \mathrm{P}_{0}+ & + & 7.00 \% & = & 13.00 \% &\mathrm{D}_{1} / \mathrm{P}_{0}=\mathrm{r}-\mathrm{g}=6.00 \%\
B&\mathrm{D}_{1} / \mathrm{P}_{0} & + & 7.00 \% & = & 11.80 \%&\mathrm{D}_{1} / \mathrm{P}_{0}=r-g=4.80 \%
\end{array}$

Stocks a and B Have the Following Data AB‾ Beta 1.100.90 Constant growth rate 7.00%7.00%\begin{array}{lcc}& \mathrm{A}& \underline{\mathrm{B}}\\\text { Beta } &1.10&0.90\\\text { Constant growth rate } & 7.00 \% & 7.00 \%\end{array} Beta Constant growth rate ​A1.107.00%​B​0.907.00%​

Stocks a and B Have the Following Data $\begin{array}{lcc}& \mathrm{A}& \underline{\mathrm{B}}\\\text { Beta } &1.10&0.90\\\text { Constant growth rate } & 7.00 \% & 7.00 \%\end{array}$