Problem 11-07

The security market line is estimated to be

k=5% + (11.6% - 5%).

You are considering two stocks. The beta of A is 1.3. The firm offers a dividend yield during the year of 3 percent and a growth rate of 5.8 percent. The beta of B is 1.0. The firm offers a dividend yield during the year of 4.8 percent and a growth rate of 5.3 percent.

Stock A: %

Stock B: %

The difference in the required rates of return is the result of -Select-stock Astock BItem 3 being riskier.

Stock A -Select-shouldshould notItem 4 be purchased.

Stock B -Select-shouldshould notItem 5 be purchased.

-Select-Stock AStock BNeither of stocksBoth stocksItem 6 should be purchased.

1. What is the required return for each security? Round your answers to two decimal places.
2. Why are the required rates of return different?
3. Since A offers higher potential growth, should it be purchased?
4. Since B offers higher dividend yield, should it be purchased?
5. Which stock(s) should be purchased?