There are two companies, AA and BB, each with current annual earnings of $2 per share

and book value of $15 per share. AA trades for $20 per share and BB trades for $30 per

share.

(a) According to their book to market ratio, which company is more of a "value stock" and

which is more of a "growth stock"?

Growth stock: Value stock:

(b) Assume AA and BB are both priced efficiently and according to the constant dividend

growth model. If both stocks pay half their earnings as an annual dividend, and both stock's

earnings grow at an average rate 3% per year forever, what is the expected return for AA and

BB over the next year?