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?
A B
Price $25 $25
Expected growth (constant) 10% 5%
Required return 15% 15% ​
a) Currently the two stocks have the same price, but over time Stock B's price will pass that of A.
b) 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.
c) The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
d) Stock A has a higher dividend yield than Stock B.
e) Stock A's expected dividend at t = 1 is only half that of Stock B.

Answer 1

Answer:

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

Explanation:

The Dividend growth model assumes that the growth of share price of stock is related to growth in its dividends. The price of both stock A and B in the given question is same but their growth rate is different. The growth rate of stock A is twice of stock B. The required return of both stock is same which means investors are nor considering growth rate for defining the rate of return. The stock A dividend at time t=1 will be half of stock B.