Problem 11-07

The security market line is estimated to be

k=7% + (12.2% - 7%).

You are considering two stocks. The beta of A is 1.1. The firm offers a dividend yield during the year of 5 percent and a growth rate of 5.2 percent. The beta of B is 1.5. The firm offers a dividend yield during the year of 6.5 percent and a growth rate of 4.3 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 / Stock B) being riskier.

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

Stock A ( should / should not) be purchased.

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

Stock B (should / should not) be purchased.

e. Which stock(s) should be purchased?

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