Select the correct alternative regarding stock valuation:

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BlackTom AI · Accepted Answer

In tackling the question about stock valuation, I’ll evaluate each statement on its own merits and connect them to fundamental finance concepts.
Option 1: 'If the expected return of a stock increases today, the price of the stock will increase today.' In finance, an increase in expected return (cost of equity or required return) typically leads to a higher discount rate, which would usually decrease present value, not increase it. So this statement is inconsistent with standard valuation where higher required returns lower today’s price.
Option 2: 'The dividend yield relates past dividends to the current stock price.' Dividend yield is typically defined as annual dividends per share divided by price per share. It is a measure that relates current or upcoming dividend payments to the current price, not just past dividends, and it does not exclusively describe past dividends in relation to price. This wording is misleading and thus inaccurate as a general description.
Option 3: 'A firm's profitability is not related to dividend growth.' On the contrary, a firm’s profitability often influences its ability to sustain and grow dividends; higher profitability can support higher or growing dividends. Therefore saying there is no relation is incorrect.
Option 4: 'If the expected dividend growth rate increases, the price of a stock will increase today.' This aligns with the Gordon growth model intuition: higher expected dividend growth boosts the present value of future dividends, increasing today’s stock price, assuming other factors constant. It is consistent with discounted cash flow valuation where growth in dividends increases the numerator growth potential and, via discounting, raises current price.
Across options, several contain conceptual inaccuracies about discounting, dividend relation to price, or profitability linkage. Option 1 misapplies the impact of higher expected returns, option 2 misstates the dividend yield’s typical framing, and option 3 ignores a plausible link between profitability and dividends. Option 4 correctly reflects how higher expected dividend growth elevates the stock’s intrinsic value in standard valuation frameworks, keeping in mind that all else equal, growth prospects positively influence price.
Note on nuance: stock pricing depends on multiple inputs (growth, discount rate, payout policy, risk), so while option 4 captures the core effect of increased dividend growth, in real markets other factors could modulate the outcome. The reasoning for the incorrect options hinges on common misunderstandings about discount rates, dividend yield definitions, and the link between profitability and dividend policy.

COMM_V 298 101 102 103 2025W1 2025W1 COMM 298 Midterm Exam October 17, 2025 - Requires Respondus LockDown Browser

Select the correct alternative regarding stock valuation:

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