40.
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?
A
B
Beta
1.10
0.90
Constant growth rate
7.00%
7.00%
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.
ANS: A
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.
r
RF
beta
RP
M
r
Stock
A
6.40%
+
1.10
Ă—
6.00%
=
13.00%
B
6.40%
+
0.90
Ă—
6.00%
=
11.80%
Div. Yld.
g
r
Stock
A
D
1
/P
0
+
7.00%
=
13.00%
D
1
/P
0
= r
âˆ’
g = 6.00%
B
D
1
/P
0
+
7.00%
=
11.80%
D
1
/P
0
= r
âˆ’
g = 4.80%

PTS:
1
DIF:
Difficulty: Moderate
OBJ:
LO: 7-5
NAT:
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC:
TBA
TOP:
Constant growth model: CAPM
KEY:
Bloomâ€™s: Analysis
MSC:
TYPE: Multiple Choice: Conceptual
NOT:
Question may require calculations to find the correct answer.
41.
A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate
of return is r
s
= 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current
price?

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b.
$17.84
c.
$18.29
d.
$18.75
e.
$19.22
ANS: C
D
1
$0.75
r
s
10.5%
g
6.4%
P
0
= D
1
/(r
s
âˆ’
g)
$18.29
PTS:
1
DIF:
Difficulty: Easy
OBJ:
LO: 7-5
NAT:
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC:
TBA
TOP:
Constant growth valuation
KEY:
Bloomâ€™s: Application
MSC:
TYPE: Multiple Choice: Problem
42.
A stock just paid a dividend of D
0
= $1.50. The required rate of return is r
s
= 10.1%,
and the constant growth rate is g = 4.0%. What is the current stock price?

PTS:
1
DIF:
Difficulty: Easy
OBJ:
LO: 7-5
NAT:
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC:
TBA
TOP:
Constant growth valuation
KEY:
Bloomâ€™s: Application
MSC:
TYPE: Multiple Choice: Problem
43.
A share of Lash Inc.'s common stock just paid a dividend of $1.00. If the expected
long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 11.4%, what is
the stock price?

P
0
= D
1
/(r
s
âˆ’
g)
$17.57
PTS:
1
DIF:
Difficulty: Easy
OBJ:
LO: 7-5
NAT:
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC:
TBA
TOP:
Constant growth valuation
KEY:
Bloomâ€™s: Application
MSC:
TYPE: Multiple Choice: Problem