Purchase Solution

# stock sensitive to changes in risk premiums & growth expectations

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Here is information on Stock A and B:

Stock A Stock B
Expected Dividends Next Year \$1.00 \$2.33
Expected Constant ROE 20% 20%
Expected Retention Rate 70% 30%
Required Return on Stocks of = risk 20% 20%

Which stock is more sensitive to changes in risk premiums and growth expectations?
Also, would you consider either a true growth stock?

##### Solution Summary

The expert examines stock sensitive to changes in risk premiums and growth expectations. A situational stock is analyzed.

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Stock A: g=ROE*Retention Rate = 0.2*0.7=0.14
Then Po = D1 / (k-g) = 1/(0.2-0.14) = \$ 16.67

Stock B: g=ROE*Retention Rate = 0.2*0.3=0.06
Then Po = D1 / (k-g) = 2.33/(0.2-0.06) = \$ 16.64

Their price are almost the same, however, we notice the major difference between the two stocks are their dividends and growth rate (which results from different retention rate)

The denominator of stock ...

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