f a stock’s dividend is expected to grow at a constant rate of 5% a year, which
ID: 2753990 • Letter: F
Question
f a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.
The expected return on the stock is 10% a year.
The stock’s dividend yield is 5%.
The price of the stock is expected to decline in the future.
The stock’s required return must be equal to or less than 5%.
The stock’s price one year from now is expected to be below the current price.
The expected return on the stock is 10% a year.
The stock’s dividend yield is 5%.
The price of the stock is expected to decline in the future.
The stock’s required return must be equal to or less than 5%.
The stock’s price one year from now is expected to be below the current price.
Explanation / Answer
stock’s required return=growth rate+Dividend yield
growth rate=5%
also Dividend yield>0 always since the Dividend yield=Expected Dividend/Price ,since Expected Dividend and Price are always>0 Dividends and price cannot be negative implies Expected Dividend/Price>0 or Dividend yield>0.
Thus , stock’s required return=5%+Dividend yield>5%+0
stock’s required return>5%,threfore The stock’s required return must be equal to or less than 5% is incorrrect.
The stock price increases with the growth rate 5% therefore The stock’s price one year from now is expected to be below the current price. and The price of the stock is expected to decline in the future. are incorrect.
We cannot predict dividend yield based on given information threfore The stock’s dividend yield is 5% is incorrect.
If The stock’s dividend yield is 5%. then stock’s required return=5%+Dividend yield=5%+5%=10% thus The expected return on the stock is 10% a year.Thus the statment The expected return on the stock is 10% a year. is correct.(seems to be correct although it cannot be ascertained given the information)
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