Bayside Marina just announced it is increasing its annual dividend from $1.45 per share to $1.48 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price:

A. was unaffected by the announcement

B. increased proportionately with the dividend increase

C. decreased proportionately with the dividend increase

D. decreased by $0.03 per share

E. increased by $0.03 per share

The correct option B, stock price increased proportionately with the dividend increase

Explanation:

To a rational investor, the price tag on a share is given by the expected dividend divided by the investor's rate of return.

To illustrate this further, the increase in dividend in percentage terms is calculated thus:

= ($1.48-$1.45) / $1.45=2.07%

The divided has increased by 2.07%

Assuming investor's rate of return is 10%, we can calculate the price of the stock when dividend is $1.45 as well as when it is $1.48

price=$1.45/0.1=$14.5

price=$1.48/0.1=$14.8

The increase in price is computed thus:

(14.8-14.5) / 14.5=2.07%

There is no doubt that an increase in dividend of 2.07% brought about the same increase share price, hence choice of answer.