Problem 11-07

The security market line is estimated to be

k=7% + (9.1% - 7%).

You are considering two stocks.

The beta of A is 1.6.

The firm offers a dividend yield during the year of 4 percent and a growth rate of 8.6 percent.

The beta of B is 1.8.

The firm offers a dividend yield during the year of 5.8 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 -Select-(stock A or stock B)... being riskier.

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

Stock A -Select-(should or should not)..... be purchased.

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

Stock B -Select-(should or should not) .... be purchased.

e. Which stock(s) should be purchased?

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