Which of the following statements is CORRECT,assuming stocks are in equilibrium?
A) The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
B) Assume that the required return on a given stock is 13%.If the stock's dividend is growing at a constant rate of 5%,then its expected dividend yield is 5% as well.
C) A stock's dividend yield can never exceed its expected growth rate.
D) A required condition for one to use the constant growth model is that the stock's expected growth rate exceed its required rate of return.
E) Other things held constant,the higher a company's beta coefficient,the lower its required rate of return.

Question

Quizplus · Accepted Answer

In equilibrium, a constant growth stock's dividend yield must equal its expected total return minus its expected capital gains yield. The dividend yield is the expected annual dividend divided by the current stock price, and the expected total return is the sum of the dividend yield and the expected capital gains yield. Therefore, the equation for equilibrium can be written as:

Dividend yield = Expected total return - Expected capital gains yield

A is the only statement that correctly reflects this relationship. B is incorrect because the dividend yield will not equal the constant growth rate if the required return is different from the growth rate. C is incorrect because the dividend yield can exceed the expected growth rate if the expected total return is high enough. D is incorrect because the expected growth rate must be less than the required rate of return for the constant growth model to be used. E is incorrect because a higher beta coefficient indicates higher risk and therefore a higher required rate of return, all else equal.

Which of the Following Statements Is CORRECT,assuming Stocks Are in Equilibrium