Critical thinking problem: Please choose the answer MOST LIKELY to be true. In a few sentences, explain

why.

You are considering buying the stocks of two companies that operate in the same industry; they have

very similar characteristics except for their dividend payout policies. Both companies are expected to

earn $6 per share this year. However, Company D (for dividend) is expected to pay out all of its

earnings as dividends, while Company G (for growth) is expected to pay out only one-third of its

earnings, or $2 per share. Ds stock price is $40. G and D are equally risky. Which of the following is most

likely to be true?

a. Company G will have a faster growth rate than Company D. Therefore, Gs stock price should be

greater than $40.

b. Although Gs growth rate should exceed Ds, Ds current dividend exceeds that of G, and this should

cause Ds price to exceed Gs.

c. An investor in Stock D will get his or her money back faster because D pays out more of its earnings as

dividends. Thus, in a sense, D is like a short-term bond, and G is like a long-term bond.

d. Ds expected and required rate of return is 15%. Gs expected return will be higher because of its

higher expected growth rate.

e. If we observe that Gs price is also $40, the best estimate of Gs growth rate is 10 percent.