The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?
A) 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.
B) 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.
C) 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.
D) The stocks must sell for the same price.
E) Stock Y must have a higher dividend yield than Stock X.
Multiple Choice: Problems
Most of these problems are straightforward and only moderately difficult. However, a few of the later ones are relatively difficult and should be used primarily on take-home exams for students with some experience with Excel. Problems with * in the topic line are nonalgorithmic.

Question

Quizplus · Accepted Answer

According to the dividend discount model, the required return of a stock can be decomposed into two parts: the expected dividend yield and expected capital gains yield. The expected dividend yield is determined by the current dividend and the price of the stock, while the expected capital gains yield is determined by the expected growth rate of the dividend. Therefore, if Stock Y has the lower expected dividend yield, it must have the higher expected growth rate to achieve the same required return as Stock X, assuming that the market is in equilibrium.

The Required Returns of Stocks X and Y Are RX