Question

True or false? An increase in the required return on a stock will decrease its market value, all else the same

Answer 1

TRUE.

A change in the required rate of return effects the price that Investor will be ready to pay. Since Price is the function of Future Cash Flows(dividend in case of stock) divided by the required rate of return. Mathematically, when the required rate of return increases, the prices falls down.

For example, An investor has a required rate of 8% and let growth rate of dividends for a firm is 3 percent indefinitely and the current dividend payment is $2.50 per year. According to the Gordon growth model, the maximum price the investor should pay is $50 ($2.50 / (0.08 - 0.03)).

Now, let's increase the required rate of return be 10%, all other constants, now the price will be $35.71 ($2.50 / (0.1 - 0.03)).

Here, required rate increase resulted in decrease in the price.

NOTE: The answer to your question has been given below/above. If there is any query regarding the answer, please ask in the comment section. If you like the answer, do upvote. Help us help you.