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? $$\begin{array} { l c r }
&\text {A}&\text {B}\
\text { Price } & \$ 25 & \$ 25 \
\text { Expected growth (constant) } & 10 \% & 5 \% \
\text { Required return } & 15 \% & 15 \%
\end{array}$$
A)Stock A has a higher dividend yield than Stock B.
B)Currently the two stocks have the same price, but over time Stock B's price will pass that of A.
C)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.
D)The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
E)Stock A's expected dividend at t = 1 is only half that of Stock B.

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? $$\begin{array} { l c r } 
&\text {A}&\text {B}\
\text { Price } & \$ 25 & \$ 25 \
\text { Expected growth (constant) } & 10 \% & 5 \% \
\text { Required return } & 15 \% & 15 \%
\end{array}$$
A)Stock A has a higher dividend yield than Stock B.
B)Currently the two stocks have the same price, but over time Stock B's price will pass that of A.
C)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.
D)The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
E)Stock A's expected dividend at t = 1 is only half that of Stock B.

Quizplus · Accepted Answer

The expected dividend for Stock A at t=1 can be calculated as follows: 
Expected Dividend A = Price A * Expected growth rate A = $25 * 10% =$2.50 
The expected dividend for Stock B at t=1 can be calculated as follows: 
Expected Dividend B = Price B * Expected growth rate B = $25 * 5% =$1.25

Therefore, Stock A's expected dividend at t=1 is only half that of Stock B. None of the other statements are correct. Stock A's higher growth rate means it has higher future earnings potential, but this does not necessarily translate into twice the future dividends. The fact that both stocks have the same required return indicates that they are in equilibrium and should sell at the same current price. Thus, choice E is the correct answer.

Stocks a and B Have the Following Data A)Stock a Has a Higher Dividend Yield Than Stock B