Two stocks, A and B, have the same price. However, stock A has a dividend growth twice that of stock B. If the recent dividend on A was half that on B, the expected return on A equals 5% and B's dividend growth rate is 2%, the expected return on B is:
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A. B. C. D.B
In the usual notation, Po = D1/(k-g) and D1 = Do*(1+g). Hence, Po = Do*(1+g)/(k-g).
The dividend growth rate of A equals 2 * 2% = 4%. We have been given PoA = PoB. Therefore, DoA*(1 + 4%)/(kA - 4%) = DoB*(1 + 2%)/(kB - 2%). Also, DoA =
0.5* DoB and kA = 5%. Thence, 0.5 * 1.04/(5% - 4%) = 1.02/(kB - 2%). Solving for kB gives the expected return on B equal to 3.96%