Problem 11-07

The security market line is estimated to be

k=5% + (12.5% - 5%).

You are considering two stocks. The beta of A is 1.7. The firm offers a dividend yield during the year of 4 percent and a growth rate of 8.5 percent. The beta of B is 2.1. The firm offers a dividend yield during the year of 5.3 percent and a growth rate of 7.8 percent.

A.What is the required return for each security? Round your answers to two decimal places.

Stock A: %_____

Stock B: %______

B.Why are the required rates of return different?

The difference in the required rates of return is the result of (stock A or stock B) being riskier.

C.Since A offers higher potential growth, should it be purchased?

Stock A (should or should not) be purchased.

D.Since B offers higher dividend yield, should it be purchased?

Stock B (should or should not) be purchased.

E.Which stock(s) should be purchased?

(Stock A, Stock B, Neither of stocks or Both stocks) should be purchased.