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Which of the following statements is CORRECT, assuming stocks are in equilibrium?
The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield. Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well. A stock’s dividend yield can never exceed its expected growth rate. A required condition for one to use the constant growth model is that the stock’s expected growth rate exceeds its required rate of return. Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return.

Answer :

Answer:

The correct answer is "The dividend yield on a constant growth stock must equal its expected capital gains yield."

Explanation:

Dividend yield can be described as an estimate of dividend only return on the stock of a company. It can be calculated by the ratio of annual dividend and share price.

So, with an increase in share price the yield will decline and  with a decrease in share prices it will rise. It tells what percentage of return the company is paying as dividend.

Constant growth stock is that stock whose dividend grows at a constant growth rate.

The capital gains yield is the rise in the price of a security. It does not include dividends.

The total returns include capital gains, dividends, distributions, interest etc. It comprises of capital gains yield and dividends.

So, the dividend yield on constant growth stock must be equal to the difference between its total expected return and expected capital gains yield.

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