stock valuation.doc

8/19/2019 Stock Valuation.doc

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Multiple Choice: Conceptual

Easy:

Required return Answer: e Diff: E

1. An increase in a firm’s expected growth rate would normally cause thefirm’s required rate of return to

a. Increase.

b. Decrease.

c. Fluctuate.

d. Remain constant.

e. ossibly increase! possibly decrease! or possibly remain unchanged.

Required return Answer: d Diff: E

". If the expected rate of return on a stoc# exceeds the required rate!

a. $he stoc# is experiencing supernormal growth.b. $he stoc# should be sold.

c. $he company is probably not trying to maximi%e price per share.

d. $he stoc# is a good buy.

e. Di&idends are not being declared.

Required return Answer: a Diff: E

'. (toc# A has a required return of 1) percent. Its di&idend is expected to

grow at a constant rate of * percent per year. (toc# + has a required

return of 1" percent. Its di&idend is expected to grow at a constant rate

of , percent per year. (toc# A has a price of -" per share! while (toc#

+ has a price of -/) per share. 0hich of the following statements is most

correct

a. $he two stoc#s ha&e the same di&idend yield.

b. If the stoc# mar#et were efficient! these two stoc#s should ha&e the

same price.

c. If the stoc# mar#et were efficient! these two stoc#s should ha&e the

same expected return.

d. (tatements a and c are correct.

e. All of the statements abo&e are correct.

Chapter 8 - Page 1


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Constant growth model Answer: a Diff: E

/. 0hich of the following statements is most correct

a. $he constant growth model ta#es into consideration the capital gains

earned on a stoc#.

b. It is appropriate to use the constant growth model to estimate stoc#

&alue e&en if the growth rate ne&er becomes constant.

c. $wo firms with the same di&idend and growth rate must also ha&e the

same stoc# price.



Constant growth model Answer: a Diff: E

. 0hich of the following statements is most correct

a. $he stoc# &aluation model! ) 2 D134#s 5 g6! can be used for firms which

ha&e negati&e growth rates.

b. If a stoc# has a required rate of return #s 2 1" percent! and its

di&idend grows at a constant rate of percent! this implies that thestoc#’s di&idend yield is percent.

c. $he price of a stoc# is the present &alue of all expected future

di&idends! discounted at the di&idend growth rate.



Constant growth model Answer: c Diff: E

7. A stoc#’s di&idend is expected to grow at a constant rate of percent a

year. 0hich of the following statements is most correct

a. $he expected return on the stoc# is percent a year.

b. $he stoc#’s di&idend yield is percent.c. $he stoc#’s price one year from now is expected to be percent higher.



Constant growth model Answer: e Diff: E

*. (toc#s A and + ha&e the same required rate of return and the same expected

year5end di&idend 4D16. (toc# A’s di&idend is expected to grow at a

constant rate of 1) percent per year! while (toc# +’s di&idend is expected

to grow at a constant rate of percent per year. 0hich of the following

statements is most correct

a. $he two stoc#s should sell at the same price.

b. (toc# A has a higher di&idend yield than (toc# +.

c. 8urrently (toc# + has a higher price! but o&er time (toc# A will

e&entually ha&e a higher price.

d. (tatements b and c are correct.

e. 9one of the statements abo&e is correct.

Chapter 8 - Page 2


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Constant growth stock Answer: c Diff: E N

:. (toc# ; and (toc# < sell for the same price in today’s mar#et. (toc# ;

has a required return of 1" percent. (toc# < has a required return of 1)

percent. (toc# ;’s di&idend is expected to grow at a constant rate of 7

percent a year! while (toc#


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Constant growth model and CAPM Answer: a Diff: E N

11. (toc# A has a beta of 1.1! while (toc# + has a beta of ).,. $he mar#et

ris# premium! #> 5 #RF! is 7 percent. $he ris#5free rate is 7.' percent.

+oth stoc#s ha&e a di&idend! which is expected to grow at a constant rate

of * percent a year. Assume that the mar#et is in equilibrium. 0hich of

the following statements is most correct

a. (toc# A must ha&e a higher di&idend yield than (toc# +.

b. (toc# A must ha&e a higher stoc# price than (toc# +.

c. (toc# +’s di&idend yield equals its expected di&idend growth rate.



Miscellaneous issues Answer: c Diff: E

1". 0hich of the following statements is most correct

a. If a company has two classes of common stoc#! 8lass A and 8lass +! the

stoc#s may pay different di&idends! but the two classes must ha&e the

same &oting rights.b. An I= occurs whene&er a company buys bac# its stoc# on the open

mar#et.

c. $he preempti&e right is a pro&ision in the corporate charter that gi&es

common stoc#holders the right to purchase 4on a pro rata basis6 new

issues of common stoc#.

d. (tatements a and b are correct.

e. (tatements a and c are correct.

Preemptive right Answer: Diff: E

1'. $he preempti&e right is important to shareholders because it

a. Allows management to sell additional shares below the current mar#etprice.

b. rotects the current shareholders against dilution of ownership

interests.

c. Is included in e&ery corporate charter.

d. 0ill result in higher di&idends per share.

e. $he preempti&e right is not important to shareholders.

Classified stock Answer: e Diff: E

1/. 8ompanies can issue different classes of common stoc#. 0hich of the

following statements concerning stoc# classes is most correct

a. All common stoc#s fall into one of three classes? A! +! and 8.

b. >ost firms ha&e se&eral classes of common stoc# outstanding.c. All common stoc#! regardless of class! must ha&e &oting rights.

d. All common stoc#! regardless of class! must ha&e the same di&idend

pri&ileges.

e. 9one of the statements abo&e is necessarily true.

Chapter 8 - Page 4


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Efficient markets h!pothesis Answer: e Diff: E

1. 0hich of the following statements is most correct

a. If a mar#et is strong5form efficient this implies that the returns on

bonds and stoc#s should be identical.

b. If a mar#et is wea#5form efficient this implies that all public

information is rapidly incorporated into mar#et prices.c. If your uncle earns a return higher than the o&erall stoc# mar#et! this

means the stoc# mar#et is inefficient.


e. 9one of the abo&e statements is correct.

Efficient markets h!pothesis Answer: d Diff: E

17. Assume that the stoc# mar#et is semistrong5form efficient. 0hich of the

following statements is most correct

a. (toc#s and bonds should ha&e the same expected returns.

b. In equilibrium all stoc#s should ha&e the same expected returns! but

returns on stoc#s should exceed returns on bonds.

c.


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e. 9one of the statements abo&e is correct.Efficient markets h!pothesis Answer: c Diff: E

1,. 0hich of the following statements is most correct

a. (emistrong5form mar#et efficiency implies that all pri&ate and public

information is rapidly incorporated into stoc# prices.

b. >ar#et efficiency implies that all stoc#s should ha&e the same expectedreturn.

c. 0ea#5form mar#et efficiency implies that recent trends in stoc# prices

would be of no use in selecting stoc#s.

d. All of the statements abo&e are correct.


Efficient markets h!pothesis Answer: a Diff: E

"). 0hich of the following statements is most correct

a. (emistrong5form mar#et efficiency means that stoc# prices reflect all

public information.

b. An indi&idual who has information about past stoc# prices should be

able to profit from this information in a wea#5form efficient mar#et.c. An indi&idual who has inside information about a publicly traded

company should be able to profit from this information in a strong5form

efficient mar#et.


e. All the statements abo&e are correct.

Efficient markets h!pothesis Answer: e Diff: E N

"1. 0hich of the following statements is most correct

a. If a mar#et is wea#5form efficient! this means that prices rapidly

reflect all a&ailable public information.

b. If a mar#et is wea#5form efficient! this means that you can expect to

beat the mar#et by using technical analysis that relies on the chartingof past prices.

c. If a mar#et is strong5form efficient! this means that all stoc#s should

ha&e the same expected return.



Efficient markets h!pothesis Answer: a Diff: E

"". >ost studies of stoc# mar#et efficiency suggest that the stoc# mar#et is

highly efficient in the wea# form and reasonably efficient in the

semistrong form. =n the basis of these findings which of the following

statements is correct

a. Information you read in The Wall Street Journal today cannot be used toselect stoc#s that will consistently beat the mar#et.

b. $he stoc# price for a company has been increasing for the past

7 months. =n the basis of this information it must be true that the

stoc# price will also increase during the current month.

c. Information disclosed in companies’ most recent annual reports can be

used to consistently beat the mar#et.

Chapter 8 - Page 6


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Preferred stock concepts Answer: e Diff: E

"'. 0hich of the following statements is most correct

a. referred stoc#holders ha&e priority o&er common stoc#holders.

b. A big ad&antage of preferred stoc# is that preferred stoc# di&idendsare tax deductible for the issuing corporation.

c. >ost preferred stoc# is owned by corporations.


e. (tatements a and c are correct.

Preferred stock concepts Answer: e Diff: E

"/. 0hich of the following statements is most correct

a. =ne of the ad&antages to the firm associated with preferred stoc#

financing rather than common stoc# financing is that control of the

firm is not diluted.

b. referred stoc# pro&ides steadier and more reliable income to in&estors

than common stoc#.c. =ne of the ad&antages to the firm of financing with preferred stoc# is

that *) percent of the di&idends paid out are tax deductible.


e. (tatements a and b are correct.

Common stock concepts Answer: d Diff: E

". 0hich of the following statements is most correct

a. =ne of the ad&antages of common stoc# financing is that a greater

proportion of stoc# in the capital structure can reduce the ris# of a

ta#eo&er bid.

b. A firm with classified stoc# can pay different di&idends to each classof shares.

c. =ne of the ad&antages of common stoc# financing is that a firm’s debt

ratio will decrease.



Common stock concepts Answer: e Diff: E

"7. (toc# ; has a required return of 1) percent! while (toc# < has a required

return of 1" percent. 0hich of the following statements is most correct

a. (toc# < must ha&e a higher di&idend yield than (toc# ;.

b. If (toc# < and (toc# ; ha&e the same di&idend yield! then (toc# < must

ha&e a lower expected capital gains yield than (toc# ;.c. If (toc# ; and (toc# < ha&e the same current di&idend and the same

expected di&idend growth rate! then (toc# < must sell for a higher

price.



Chapter 8 - Page 7


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Declining growth stock Answer: e Diff: E

"*. A stoc# expects to pay a year5end di&idend of -".)) a share 4D1 2 -".))6.

$he di&idend is expected to fall percent a year! fore&er 4g 2 5@6. $he

company’s expected and required rate of return is 1 percent. 0hich of the

following statements is most correct

a. $he company’s stoc# price is -1).b. $he company’s expected di&idend yield years from now will be ")

percent.

c. $he company’s stoc# price years from now is expected to be -*.*/.



Dividend !ield and g Answer: d Diff: E

":. If two constant growth stoc#s ha&e the same required rate of return and

the same price! which of the following statements is most correct

a. $he two stoc#s ha&e the same per5share di&idend.

b. $he two stoc#s ha&e the same di&idend yield.

c. $he two stoc#s ha&e the same di&idend growth rate.

d. $he stoc# with the higher di&idend yield will ha&e a lower di&idend

growth rate.

e. $he stoc# with the higher di&idend yield will ha&e a higher di&idend

growth rate.

Dividend !ield and g Answer: c Diff: E

",. (toc#s A and + ha&e the same price! but (toc# A has a higher required rate

of return than (toc# +. 0hich of the following statements is most

correct

a. (toc# A must ha&e a higher di&idend yield than (toc# +.

b. (toc# + must ha&e a higher di&idend yield than (toc# A.c. If (toc# A has a lower di&idend yield than (toc# +! its expected

capital gains yield must be higher than (toc# +’s.

d. If (toc# A has a higher di&idend yield than (toc# +! its expected

capital gains yield must be lower than (toc# +’s.

e. (toc# A must ha&e both a higher di&idend yield and a higher capital

gains yield than (toc# +.

Market equilirium Answer: Diff: E N

'). If mar#ets are in equilibrium! which of the following will occur?

a. ach in&estment’s expected return should equal its reali%ed return.

b. ach in&estment’s expected return should equal its required return.

c. ach in&estment should ha&e the same expected return.

d. ach in&estment should ha&e the same reali%ed return.


Chapter 8 - Page 8


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Medium:

Market efficienc! and stock returns Answer: c Diff: M

'1. 0hich of the following statements is most correct

a. If a stoc#’s beta increased but its growth rate remained the same! then

the new equilibrium price of the stoc# will be higher 4assumingdi&idends continue to grow at the constant growth rate6.

b. >ar#et efficiency says that the actual reali%ed returns on all stoc#s

will be equal to the expected rates of return.

c. An implication of the semistrong form of the efficient mar#ets

hypothesis is that you cannot consistently benefit from trading on

information reported in The Wall Street Journal.



Efficient markets h!pothesis Answer: e Diff: M

'". 0hich of the following statements is most correct

a. If the stoc# mar#et is wea#5form efficient this means you cannot use

pri&ate information to outperform the mar#et.

b. If the stoc# mar#et is semistrong5form efficient! this means the

expected return on stoc#s and bonds should be the same.

c. If the stoc# mar#et is semistrong5form efficient! this means that high5

beta stoc#s should ha&e the same expected return as low5beta stoc#s.



Efficient markets h!pothesis Answer: c Diff: M

''. If the stoc# mar#et is semistrong5form efficient! which of the following


a. All stoc#s should ha&e the same expected returnsB howe&er! they may

ha&e different reali%ed returns.

b. In equilibrium! stoc#s and bonds should ha&e the same expected returns.

c. In&estors can outperform the mar#et if they ha&e access to information

that has not yet been publicly re&ealed.

d. If the stoc# mar#et has been performing strongly o&er the past se&eral

months! stoc# prices are more li#ely to decline than increase o&er the

next se&eral months.


Efficient markets h!pothesis Answer: e Diff: M

'/. Assume that mar#ets are semistrong5form efficient. 0hich of the following


a. All stoc#s should ha&e the same expected return.

b. All stoc#s should ha&e the same reali%ed return.

c. ast stoc# prices can be successfully used to forecast future stoc#

returns.


Chapter 8 - Page 9


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e. 9one of the statements abo&e is correct.Efficient markets h!pothesis Answer: d Diff: M

'. Assume that mar#ets are semistrong5form efficient! but not strong5form

efficient. 0hich of the following statements is most correct

a. ach common stoc# has an expected return equal to that of the o&erall

mar#et.

b. +onds and stoc#s ha&e the same expected return.

c. In&estors can expect to earn returns abo&e those predicted by the (>C

if they ha&e access to public information.

d. In&estors may be able to earn returns abo&e those predicted by the (>C

if they ha&e access to information that has not been publicly re&ealed.

e. (tatements b and c are correct.

Market equilirium Answer: a Diff: M

'7. For mar#ets to be in equilibrium! that is! for there to be no strong

pressure for prices to depart from their current le&els!

a. $he expected rate of return must be equal to the required rate ofreturnB that is! # 2 #.

b. $he past reali%ed rate of return must be equal to the expected rate of

returnB that is! # 2 # .

c. $he required rate of return must equal the reali%ed rate of returnB

that is! # 2 # .

d. All three of the statements abo&e must hold for equilibrium to existB

that is! # 2 # 2 # .


"wnership and going pulic Answer: c Diff: M

'*. 0hich of the following statements is false

a. 0hen a corporation’s shares are owned by a few indi&iduals who are

associated with or are the firm’s management! we say that the firm is

closely held.E

b. A publicly owned corporation is simply a company whose shares are held

by the in&esting public! which may include other corporations and

institutions as well as indi&iduals.

c. oing public establishes a true mar#et &alue for the firm and ensures

that a liquid mar#et will always exist for the firm’s shares.

d. 0hen stoc# in a closely held corporation is offered to the public for

the first time the transaction is called going publicE and the mar#et

for such stoc# is called the new issue mar#et.

e. It is possible for a firm to go public! and yet not raise any

additional new capital.

Chapter 8 - Page 10


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Dividend !ield and g Answer: Diff: M

':. 0hich of the following statements is most correct

a. Assume that the required rate of return on a gi&en stoc# is 1' percent.

If the stoc#’s di&idend is growing at a constant rate of percent! its

expected di&idend yield is percent as well.

b. $he di&idend yield on a stoc# is equal to the expected return less theexpected capital gain.

c. A stoc#’s di&idend yield can ne&er exceed the expected growth rate.



Constant growth model Answer: d Diff: M

',. $he expected rate of return on the common stoc# of 9orthwest 8orporation

is 1/ percent. $he stoc#’s di&idend is expected to grow at a constant

rate of : percent a year. $he stoc# currently sells for -) a share.

0hich of the following statements is most correct

a. $he stoc#’s di&idend yield is : percent.

b. $he stoc#’s di&idend yield is * percent.c. $he current di&idend per share is -/.)).

d. $he stoc# price is expected to be -/ a share in one year.

e. $he stoc# price is expected to be -* a share in one year.

Multiple Choice: Problems

Easy:

Preferred stock value Answer: d Diff: E

/). $he Gones 8ompany has decided to underta#e a large proHect. 8onsequently!

there is a need for additional funds. $he financial manager plans to

issue preferred stoc# with a perpetual annual di&idend of - per share and

a par &alue of -'). If the required return on this stoc# is currently ")

percent! what should be the stoc#’s mar#et &alue

a. -1)

b. -1))

c. - )

d. - "

e. - 1)

Preferred stock value Answer: d Diff: E

/1. Gohnston 8orporation is growing at a constant rate of 7 percent per year.

It has both common stoc# and non5participating preferred stoc#

outstanding. $he cost of preferred stoc# 4#p6 is : percent. $he par &alue

of the preferred stoc# is -1")! and the stoc# has a stated di&idend of 1)

percent of par. 0hat is the mar#et &alue of the preferred stoc#

a. -1"

b. -1")

c. -1*

d. -1)

Chapter 8 - Page 11


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e. -"))Preferred stock !ield Answer: c Diff: E

/". A share of preferred stoc# pays a quarterly di&idend of -".). If the

price of this preferred stoc# is currently -)! what is the nominal annual

rate of return

a. 1"@

b. 1:@

c. ")@

d. "'@

e. ":@

Preferred stock !ield Answer: a Diff: E

/'. A share of preferred stoc# pays a di&idend of -).) each quarter. If you

are willing to pay -").)) for this preferred stoc#! what is your nominal

4not effecti&e6 annual rate of return

a. 1)@

b. :@c. 7@

d. 1"@

e. 1/@

#tock price Answer: d Diff: E

//. Assume that you plan to buy a share of ;


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$uture stock price%%constant growth Answer: Diff: E

/7. Allegheny ublishing’s stoc# is expected to pay a year5end di&idend! D1!

of -/.)). $he di&idend is expected to grow at a constant rate of

: percent per year! and the stoc#’s required rate of return is 1" percent.

i&en this information! what is the expected price of the stoc#! eight

years from now

a. -")).))

b. -1:.),

c. -1*1.':

d. -"/*.7)

e. -1'7.:7

$uture stock price%%constant growth Answer: a Diff: E

/*. 0aters 8orporation has a stoc# price of -") a share. $he stoc#’s year5end

di&idend is expected to be -" a share 4D1 2 -".))6. $he stoc#’s required

rate of return is 1 percent and the stoc#’s di&idend is expected to grow

at the same constant rate fore&er. 0hat is the expected price of the

stoc# se&en years from now

a. -":

b. -'

c. -"*

d. -"'

e. -',

$uture stock price%%constant growth Answer: a Diff: E

/:. $rudeau $echnologies’ common stoc# currently trades at -/) per share. $he

stoc# is expected to pay a year5end di&idend! D1! of -" per share. $he

stoc#’s di&idend is expected to grow at a constant rate g! and its

required rate of return is , percent. 0hat is the expected price of the

stoc# fi&e years from today 4after the di&idend D has been paid6

Inother words! what is.

a. -/:.7*

b. -).71

c. -1.)

d. -71./)

e. -71./

$uture stock price%%constant growth Answer: e Diff: E N

/,. A stoc# is expected to pay a di&idend of -).) at the end of the year

4i.e.! D1 2 ).)6. Its di&idend is expected to grow at a constant rate of

* percent a year! and the stoc# has a required return of 1" percent. 0hat

is the expected price of the stoc# four years from today

a. - ./7

b. - ,.'7

c. -1).))

d. -1".1:

e. -1'.11

Chapter 8 - Page 13


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Constant growth stock Answer: Diff: E

). >cKenna >otors is expected to pay a -1.)) per5share di&idend at the end of

the year 4D1 2 -1.))6. $he stoc# sells for -") per share and its required

rate of return is 11 percent. $he di&idend is expected to grow at a

constant rate! g! fore&er. 0hat is the growth rate! g! for this stoc#

a. @

b. 7@

c. *@

d. :@

e. ,@

Constant growth stock Answer: a Diff: E

1. A share of common stoc# has Hust paid a di&idend of -".)). If the

expected long5run growth rate for this stoc# is 1 percent! and if

in&estors require a 1, percent rate of return! what is the price of the

stoc#

a. -*.)

b. -7"."

c. -*1.:7

d. -7/.))

e. -//.,"

Constant growth stock Answer: e Diff: E

". $hames Inc.’s most recent di&idend was -"./) per share 4D) 2 -"./)6.

$he di&idend is expected to grow at a rate of 7 percent per year. $he

ris#5free rate is percent and the return on the mar#et is , percent. If

the company’s beta is 1.'! what is the price of the stoc# today

a. -*".1/

b. -*.1/

c. -/).))

d. -7:.)7

e. -7).*

Constant growth stock Answer: c Diff: E

'. Albright >otors is expected to pay a year5end di&idend of -'.)) a share

4D1 2 -'.))6. $he stoc# currently sells for -') a share. $he required

4and expected6 rate of return on the stoc# is 17 percent. If the di&idend

is expected to grow at a constant rate! g! what is g

a. 1'.))@b. 1).)@

c. 7.))@

d. .''@

e. *.))@

Chapter 8 - Page 14


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Constant growth stock Answer: d Diff: E

/. A stoc# with a required rate of return of 1) percent sells for -') per

share. $he stoc#’s di&idend is expected to grow at a constant rate of *

percent per year. 0hat is the expected year5end di&idend! D1! on the

stoc#

a. -).:*

b. -).,

c. -1.)"

d. -).,)

e. -1.)

Constant growth stock Answer: Diff: E

. ettysburg rocers’ stoc# is expected to pay a year5end di&idend! D1! of

-".)) per share. $he di&idend is expected to grow at a constant rate of

percent! and the stoc# has a required return of , percent. 0hat is the

expected price of the stoc# fi&e years from today

a. -7*.))b. -7'.:1

c. -1.)

d. - ).7/

e. -7).:'

Constant growth stock Answer: d Diff: E

56 . A stoc# is expected to ha&e a di&idend per share of -).7) at the end of

the year 4D1 2 ).7)6. $he di&idend is expected to grow at a constant rate

of * percent per year! and the stoc# has a required return of 1" percent.

0hat is the expected price of the stoc# fi&e years from today 4$hat is!

what is.J 6

a. -1".)"

b. -1.11

c. -1.*'

d. -17.:'

e. -"1.1

Constant growth stock Answer: Diff: E N

*. A stoc# is expected to pay a -)./ di&idend at the end of the year 4D1 2

)./6. $he di&idend is expected to grow at a constant rate of / percent a

year! and the stoc#’s required rate of return is 11 percent. 0hat is the

expected price of the stoc# 1) years from today

a. -1:."b. - ,."

c. - ,.1

d. - 7.)"

e. -1".7

Chapter 8 - Page 15


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Nonconstant growth stock Answer: d Diff: E

:. $he last di&idend paid by Klein 8ompany was -1.)). Klein’s growth rate is

expected to be a constant percent for " years! after which di&idends are

expected to grow at a rate of 1) percent fore&er. Klein’s required rate

of return on equity 4#s6 is 1" percent. 0hat is the current price of

Klein’s common stoc#

a. -"1.))

b. -''.''

c. -/"."

d. -).17

e. -:.*

Nonconstant growth stock Answer: d Diff: E

,.


17/79

e. - ".)$C$ model for valuing stock Answer: d Diff: E N

7". An analyst is trying to estimate the intrinsic &alue of the stoc# of

Mar#leroad $echnologies. $he analyst estimates that Mar#leroad’s free

cash flow during the next year will be -" million. $he analyst also

estimates that the company’s free cash flow will increase at a constant

rate of * percent a year and that the company’s 0A88 is 1) percent.

Mar#leroad has -")) million of long5term debt and preferred stoc#! and ')

million outstanding shares of common stoc#. 0hat is the estimated per5

share price of Mar#leroad $echnologies’ common stoc#

a. - 1.7*

b. - ."/

c. -1:.'*

d. -"1.11

e. -"*.*:

$C$ model for valuing stock Answer: d Diff: E N

7'. An analyst estimating the intrinsic &alue of the Rein 8orporation stoc#estimates that its free cash flow at the end of the year 4t 2 16 will be

-')) million. $he analyst estimates that the firm’s free cash flow will

grow at a constant rate of * percent a year! and that the company’s

weighted a&erage cost of capital is 11 percent. $he company currently has

debt and preferred stoc# totaling -)) million. $here are 1) million

outstanding shares of common stoc#. 0hat is the intrinsic &alue 4per

share6 of the company’s stoc#

a. -17.7*

b. -".))

c. -''.''

d. -/7.7*

e. -).))

Medium:

Changing eta and the equilirium stock price Answer: d Diff: M

7/. 8eeHay 8orporation’s stoc# is currently selling at an equilibrium price of

-') per share. $he firm has been experiencing a 7 percent annual growth

rate. Cast year’s earnings per share! )! were -/.)) and the di&idend

payout ratio is /) percent. $he ris#5free rate is : percent! and the

mar#et ris# premium is percent. If mar#et ris# 4beta6 increases by )

percent! and all other factors remain constant! what will be the new stoc#

price 4Nse / decimal places in your calculations.6

a. -17.,

b. -1:."

c. -"1.',

d. -"".7,

e. -'./:

Chapter 8 - Page 17


18/79

Equilirium stock price Answer: Diff: M

7. L #RF! is

* percent and the ris#5free rate is percent. 0hat is the expected price

of


19/79

e. -77.1 Nonconstant growth stock Answer: a Diff: M

7:. >otor Momes Inc. 4>MI6 is presently in a stage of abnormally high growth

because of a surge in the demand for motor homes. $he company expects

earnings and di&idends to grow at a rate of ") percent for the next

/ years! after which time there will be no growth 4g 2 )6 in earnings and

di&idends. $he company’s last di&idend was -1.). >MI’s beta is 1.7! the

return on the mar#et is currently 1".* percent! and the ris#5free rate is

/ percent. 0hat should be the current common stoc# price

a. -1.1*

b. -1*.":

c. -""."1

d. -1,.1)

e. -"/.77

Nonconstant growth stock Answer: d Diff: M

7,. A stoc# is not expected to pay a di&idend o&er the next four years. Fi&e

years from now! the company anticipates that it will establish a di&idendof -1.)) per share 4i.e.! D 2 -1.))6. =nce the di&idend is established!

the mar#et expects that the di&idend will grow at a constant rate of

percent per year fore&er. $he ris#5free rate is percent! the company’s

beta is 1."! and the mar#et ris# premium is percent. $he required rate

of return on the company’s stoc# is expected to remain constant. 0hat is

the current stoc# price

a. - *.'7

b. - :.7"

c. - ,.:,

d. -1).,:

e. -11.'


*). >ac# Industries Hust paid a di&idend of -1.)) per share 4D) 2 -1.))6.

Analysts expect the company’s di&idend to grow ") percent this year 4D 1 2

-1.")6 and 1 percent next year. After two years the di&idend is expected

to grow at a constant rate of percent. $he required rate of return on

the company’s stoc# is 1" percent. 0hat should be the company’s current

stoc# price

a. -1".''

b. -17.7

c. -17.,1

d. -1:.7*e. -1,.7*

Chapter 8 - Page 19


20/79

Nonconstant growth stock Answer: a Diff: M

*1. R. . Cee recently too# his company public through an initial public

offering. Me is expanding the business quic#ly to ta#e ad&antage of an

otherwise unexploited mar#et. rowth for his company is expected to be /)

percent for the first three years and then he expects it to slow down to a

constant 1 percent. $he most recent di&idend 4D)6 was -).*. +ased on

the most recent returns! his company’s beta is approximately 1.. $he

ris#5free rate is : percent and the mar#et ris# premium is 7 percent.

0hat is the current price of Cee’s stoc#

a. -**.1/

b. -*.1*

c. -7*.1

d. -*'.::

e. -,'.")


*". A stoc# is expected to pay no di&idends for the first three years! that

is! D1 2 -)! D" 2 -)! and D' 2 -). $he di&idend for


21/79

Nonconstant growth stock Answer: Diff: M

*/. >cherson nterprises is planning to pay a di&idend of -"." per share at

the end of the year 4D1 2 -"."6. $he company is planning to pay the same

di&idend each of the following " years and will then increase the di&idend

to -'.)) for the subsequent " years 4D/ and D6. After that time the

di&idends will grow at a constant rate of percent per year. If the

required return on the company’s common stoc# is 11 percent per year! what

is its current stoc# price

a. -".)

b. -/)./1

c. -'*.)

d. -).))

e. -'".,/

Nonconstant growth stock Answer: Diff: M

*. Madloc# Mealthcare expects to pay a -'.)) di&idend at the end of the year

4D1 2 -'.))6. $he stoc#’s di&idend is expected to grow at a rate of 1)

percent a year until three years from now 4t 2 '6. After this time! thestoc#’s di&idend is expected to grow at a constant rate of

percent a year. $he stoc#’s required rate of return is 11 percent.

0hat is the price of the stoc# today

a. -/,

b. -/

c. -7/

d. -"

e. -:,

Nonconstant growth stock Answer: e Diff: M

*7

. Rogers Robotics currently 4"))'6 does not pay a di&idend. Mowe&er! thecompany is expected to pay a -1.)) di&idend two years from today 4"))6.

$he di&idend is then expected to grow at a rate of ") percent a year for

the following three years. After the di&idend is paid in ")):! it is

expected to grow fore&er at a constant rate of * percent. 8urrently! the

ris#5free rate is 7 percent! mar#et ris# premium 4#> L #RF6 is

percent! and the stoc#’s beta is 1./. 0hat should be the price of the

stoc# today

a. -"".,1

b. -"1.")

c. -').:"

d. -":.:)

e. -").17

Chapter 8 - Page 21


22/79

Nonconstant growth stock Answer: c Diff: M

**. 0hitesell $echnology has Hust paid a di&idend 4D)6 and is expected to pay

a -".)) per5share di&idend at the end of the year 4D 16. $he di&idend is

expected to grow " percent a year for the following four years! 4D 2

-".)) × 41."6/ 2 -/.::":6. After this time period! the di&idend will

grow fore&er at a constant rate of * percent a year. $he stoc# has a

required rate of return of 1' percent 4#s 2 ).1'6. 0hat is the expected

price of the stoc# two years from today 48alculate the price assuming

that D" has already been paid.6

a. -:'.,*

b. -,.:*

c. -7,.7

d. -7*.7'

e. -,1.,7

Nonconstant growth stock Answer: e Diff: M

*:. A stoc#! which currently does not pay a di&idend! is expected to pay its

first di&idend of -1.)) per share in fi&e years 4D 2 -1.))6. After thedi&idend is established! it is expected to grow at an annual rate of "

percent per year for the following three years 4D: 2 -1.,'1"6 and then

grow at a constant rate of percent per year thereafter. Assume that the

ris#5free rate is . percent! the mar#et ris# premium is / percent! and

that the stoc#’s beta is 1.". 0hat is the expected price of the stoc#

today

a. -"'.:*

b. -').7

c. -1:.*"

d. -").,

e. -").7


*,. An analyst estimates that 8heyenne 8o. will pay the following di&idends?

D1 2 -'.))))! D" 2 -'.*))! and D' 2 -/.'1". $he analyst also estimates

that the required rate of return on 8heyenne’s stoc# is 1"." percent.

After the third di&idend! the di&idend is expected to grow by : percent

per year fore&er. 0hat is the price of the stoc# today

a. -:1./)

b. -:/.17

c. -:."*

d. -:*.""

e. -,/.)"

Chapter 8 - Page 22


23/79


:). Cewisburg 8ompany’s stoc# is expected to pay a di&idend of -1.)) per share

at the end of the year. $he di&idend is expected to grow ") percent per

year each of the following three years 4D/ 2 -1.*":)6! after which time

the di&idend is expected to grow at a constant rate of * percent per year.

$he stoc#’s beta is 1."! the mar#et ris# premium is / percent! and the

ris#5free rate is percent. 0hat is the price of the stoc# today

a. -/,.71

b. -/.7

c. -/:./'

d. -/7.7/

e. -/./


:1. 9amath 8orporation’s stoc# is expected to pay a di&idend of -1." per

share at the end of the year. $he di&idend is expected to increase by ")

percent per year for each of the following two years. After that! the

di&idend is expected to increase at a constant rate of : percent per year.$he stoc# has a required return of 1) percent. 0hat should be the price

of the stoc# today

a. -).))

b. -,.':

c. -*).11

d. -*7.*7

e. -:/./'

Nonconstant growth stock Answer: Diff: M N

:". A stoc# is expected to pay a di&idend of -1.)) at the end of the year

4i.e.! D1 2 -1.))6. $he di&idend is expected to grow " percent each ofthe following two years! after which time it is expected to grow at a

constant rate of 7 percent a year. $he stoc#’s required return is 11

percent. Assume that the mar#et is in equilibrium. 0hat is the stoc#’s

price today

a. -"7.1/

b. -"*.":

c. -')./:

d. -'".*1

e. -'.':

Chapter 8 - Page 23


24/79

Nonconstant growth stock Answer: c Diff: M

:'. arcia Inc. has a current di&idend of -'.)) per share 4D) 2 -'.))6.

Analysts expect that the di&idend will grow at a rate of " percent a year

for the next three years! and thereafter it will grow at a constant rate

of 1) percent a year. $he company’s cost of equity capital is estimated

to be 1 percent. 0hat is arcia’s current stoc# price

a. - *.))

b. - ::.

c. - ,./"

d. -1)'."

e. -11).))


:/. Molmgren Motels’ stoc# has a required return of 11 percent. $he stoc#

currently does not pay a di&idend but it expects to begin paying a

di&idend of -1.)) per share starting fi&e years from today 4D 2 -1.))6.

=nce established the di&idend is expected to grow by " percent per year

for two years! after which time it is expected to grow at a constant rate

of 1) percent per year. 0hat should be Molmgren’s stoc# price today

a. - :/.:)

b. -1*/.'/

c. - *7.7)

d. - ,/.1'

e. - **."*

Nonconstant growth stock Answer: a Diff: M N

:. A stoc# Hust paid a -1.)) di&idend 4D) 2 1.))6. $he di&idend is expected to

grow " percent a year for the next four years! after which time the di&idend

is expected to grow at a constant rate of percent a year. $he stoc#’s

required return is 1" percent. 0hat is the price of the stoc# today

a. -":.:

b. -"7.)7

c. -'".)1

d. - ,.7"

e. -"*./*

#upernormal growth stock Answer: e Diff: M

:7. A share of stoc# has a di&idend of D) 2 -. $he di&idend is expected to

grow at a ") percent annual rate for the next 1) years! then at a 1

percent rate for 1) more years! and then at a long5run normal growth rate

of 1) percent fore&er. If in&estors require a 1) percent return on this

stoc#! what is its current price

a. -1)).))

b. - :".'

c. -1,.)

d. -"1".7"

e. $he data gi&en in the problem are internally inconsistent! that is! the

situa5tion described is impossible in that no equilibrium price can be

Chapter 8 - Page 24


25/79

produced.#upernormal growth stock Answer: Diff: M

:*. A+8 8ompany has been growing at a 1) percent rate! and it Hust paid a

di&idend of D) 2 -'.)). Due to a new product! A+8 expects to achie&e a

dramatic increase in its short5run growth rate! to ") percent annually for

the next " years. After this time! growth is expected to return to the

long5run constant rate of 1) percent. $he company’s beta is ".)! the

required return on an a&erage stoc# is 11 percent! and the ris#5free rate

is * percent. 0hat should be the di&idend yield 4D13)6 today

a. '.,'@

b. /.7)@

c. 1).))@

d. *./@

e. ".''@

#upernormal growth stock Answer: Diff: M

::. DAA’s stoc# is selling for -1 per share. $he firm’s income! assets! and

stoc# price ha&e been growing at an annual 1 percent rate and areexpected to continue to grow at this rate for ' more years. 9o di&idends

ha&e been declared as yet! but the firm intends to declare a di&idend of

D' 2 -".)) at the end of the last year of its supernormal growth. After

that! di&idends are expected to grow at the firm’s normal growth rate of 7

percent. $he firm’s required rate of return is 1: percent. $he stoc# is

a. Nnder&alued by -'.)'.

b. =&er&alued by -'.)'.

c. 8orrectly &alued.

d. =&er&alued by -".".

e. Nnder&alued by -".".


:,. Faul#ner 8orporation expects to pay an end5of5year di&idend! D1! of -1.)

per share. For the next two years the di&idend is expected to grow by "

percent per year! after which time the di&idend is expected to grow at a

constant rate of * percent per year. $he stoc# has a required rate of

return of 1" percent. Assuming that the stoc# is fairly &alued! what is

the price of the stoc# today

a. -/.)'

b. -/).")

c. -'*.,*

d. -'7.':

e. -/.)'

Chapter 8 - Page 25


26/79


,). Assume that the a&erage firm in your company’s industry is expected to

grow at a constant rate of percent! and its di&idend yield is

/ percent.


27/79

d. :.:)@

e. :.':@

Capital gains !ield Answer: c Diff: M

,/. 8arlson roducts! a constant growth company! has a current mar#et 4and

equilibrium6 stoc# price of -").)). 8arlson’s next di&idend! D1! is

forecasted to be -".))! and 8arlson is growing at an annual rate of

7 percent. 8arlson has a beta coefficient of 1."! and the required rate

of return on the mar#et is 1 percent. As 8arlson’s financial manager!

you ha&e access to insider information concerning a switch in product

lines that would not change the growth rate! but would cut 8arlson’s beta

coefficient in half. If you buy the stoc# at the current mar#et price!

what is your expected percentage capital gain

a. "'@

b. ''@

c. /'@

d. '@

e. $here would be a capital loss.

Capital gains !ield Answer: d Diff: M

,. i&en the following information! calculate the expected capital gains

yield for 8hicago +ears Inc.? beta 2 ).7B #> 2 1@B #RF 2 :@B D1 2 -".))B

) 2 -".)). Assume the stoc# is in equilibrium and exhibits constant

growth.

a. '.:@

b. )@

c. :.)@

d. /."@

e. ".@

Capital gains !ield and dividend !ield Answer: e Diff: M ,7. 8onner 8orporation has a stoc# price of -'".' per share. $he last

di&idend was -'./" 4D) 2 -'./"6. $he long5run growth rate for the company

is a constant * percent. 0hat is the company’s capital gains yield and

di&idend yield

a. 8apital gains yield 2 *.))@B Di&idend yield 2 1).*@

b. 8apital gains yield 2 1).*@B Di&idend yield 2 *.))@

c. 8apital gains yield 2 *.))@B Di&idend yield 2 /.'1@

d. 8apital gains yield 2 11.'1@B Di&idend yield 2 *.))@

e. 8apital gains yield 2 *.))@B Di&idend yield 2 11.'1@

Chapter 8 - Page 27


28/79

E'pected return and P(E ratio Answer: Diff: M

,*. Camonica >otors Hust reported earnings per share of -".)). $he stoc# has

a price earnings ratio of /)! so the stoc#’s current price is -:) per

share. Analysts expect that one year from now the company will ha&e an (

of -"./)! and it will pay its first di&idend of -1.)) per share. $he stoc#

has a required return of 1) percent. 0hat price earnings ratio must the

stoc# ha&e one year from now so that in&estors reali%e their expected

return

a. //.))

b. '7."

c. /.1*

d. /).))

e. '7.7*

#tock price and P(E ratio Answer: a Diff: M

,:. During the past few years! (wanson 8ompany has retained! on the a&erage!

*) percent of its earnings in the business. $he future retention rate is

expected to remain at *) percent of earnings! and long5run earnings growth

is expected to be 1) percent. If the ris#5free rate! #RF! is : percent!

the expected return on the mar#et! #>! is 1" percent! (wanson’s beta is

".)! and the most recent di&idend! D)! was -1.)! what is the most li#ely

mar#et price and 3 ratio 4)316 for (wanson’s stoc# today

a. -"*.)B .)×

b. -''.))B 7.)×

c. -".))B .)×

d. -"".)B /.×

e. -/.))B /.×

#tock price Answer: d Diff: M

,,. 2 ,@.

• Di&idend payout ratio 2 7)@.• rowth rate 2 :@.

8alculate the current price per share for 8ali 8orporation.

a. -'.""

b. -/7."*

c. -/:.

Chapter 8 - Page 28


29/79

d. -'.*"

e. -,.*7

Chapter 8 - Page 29


30/79

&eta coefficient Answer: c Diff: M

1)). As financial manager of >aterial (upplies Inc.! you ha&e recently

participated in an executi&e committee decision to enter into the plastics

business. >uch to your surprise! the price of the firm’s common stoc#

subsequently declined from -/) per share to -') per share. 0hile there

ha&e been se&eral changes in financial mar#ets during this period! you are

anxious to determine how the mar#et percei&es the rele&ant ris# of your

firm. Assume that the mar#et is in equilibrium. From the following data

you find that the beta &alue associated with your firm has changed from an

old beta of to a new beta of .

• $he real ris#5free rate is " percent! but the inflation premium has

increased from / percent to 7 percent.

• $he expected growth rate has been re5e&aluated by security analysts! and

a 1). percent rate is considered to be more realistic than the pre&ious

percent rate. $his change had nothing to do with the mo&e into

plasticsB it would ha&e occurred anyway.

• $he ris# a&ersion attitude of the mar#et has shifted somewhat! and now

the mar#et ris# premium is ' percent instead of " percent.

• $he next di&idend! D1! was expected to be -" per share! assuming the

oldE percent growth rate.

a. ".))B 1.)

b. 1.)B '.))

c. ".))B '.1*

d. 1.7*B ".))

e. 1.)B 1.7*

Risk and stock value Answer: d Diff: M

1)1. $he probability distribution for #> for the coming year is as follows?

robability #> ).) *@

).') :

).') ,

).') 1)

).) 1"

If #RF 2 7.)@ and (toc# ; has a beta of ".)! an expected constant growth

rate of * percent! and D) 2 -"! what mar#et price gi&es the in&estor a

return consistent with the stoc#’s ris#

a. -".))

b. -'*.)

c. -"1.*"d. -/".':

e. -7.,/

Chapter 8 - Page 30


31/79

$uture stock price%%constant growth Answer: Diff: M

1)". 9ewburn ntertainment’s stoc# is expected to pay a year5end di&idend of

-'.)) a share 4D1 2 -'.))6. $he stoc#’s di&idend is expected to grow at a

constant rate of percent a year. $he ris#5free rate! #RF! is

7 percent and the mar#et ris# premium! 4#> L #RF6! is percent. $he stoc#

has a beta of ).:. 0hat is the stoc#’s expected price fi&e years from

now

a. -7).))

b. -*7.:

c. -,7.7'

d. -*".11

e. -7:.,7

$uture stock price%%constant growth Answer: e Diff: M

1)'. A stoc# currently sells for -": a share. Its di&idend is growing at a

constant rate! and its di&idend yield is percent. $he required rate of

return on the company’s stoc# is expected to remain constant at 1'

percent. 0hat is the expected stoc# price se&en years from now

a. -"/.7"

b. -",.,,

c. -',./)

d. -/1.:'

e. -/*.,,


1)/. raham nterprises anticipates that its di&idend at the end of the year

will be -".)) a share 4D1 2 -".))6. $he di&idend is expected to grow at a

constant rate of * percent a year. $he ris#5free rate is 7 percent! the

mar#et ris# premium is percent! and the company’s beta equals 1.". 0hat

is the expected stoc# price fi&e years from now

a. -"./'

b. -7.1)

c. -7'./,

d. -*)./,

e. -*"./


1). Kir#land >otors expects to pay a -".)) per share di&idend on its common

stoc# at the end of the year 4D1 2 -".))6. $he stoc# currently sells for

-").)) a share. $he required rate of return on the company’s stoc# is 1"

percent 4#s 2 ).1"6. $he di&idend is expected to grow at some constantrate o&er time. 0hat is the expected stoc# price fi&e years from now!

that is! what is .J

a. -"1.7

b. -"".):

c. -".7/

Chapter 8 - Page 31


32/79

d. -'."

e. -'7.*:


1)7. >c9ally >otors has yet to pay a di&idend on its common stoc#. Mowe&er!

the company expects to pay a -1.)) di&idend starting two years from now

4D" 2 -1.))6. $hereafter! the stoc#’s di&idend is expected to grow at a

constant rate of percent a year. $he stoc#’s beta is 1./! the ris#5free

rate is #RF 2 ).)7! and the expected mar#et return is #> 2 ).1". 0hat is

the stoc#’s expected price four years from now! that is! what

is/

a. -1).7'

b. -1".'"

c. -11.:*

d. -1'.:

e. -11."1


1)*. Dawson nergy is expected to pay an end5of5year di&idend! D1! of -".)) pershare! and it is expected to grow at a constant rate o&er time. $he stoc#

has a required rate of return of 1/ percent and a di&idend yield! D13)! of

percent. 0hat is the expected price of the stoc# fi&e years from today

a. -**.)"

b. -71./

c. -7./7

d. -/).))

e. -1.)

$uture stock price%%constant growth Answer: e Diff: M N

1):. A stoc# is expected to pay a -".) di&idend at the end of the year 4D1 2

-".)6. $he di&idend is expected to grow at a constant rate of

7 percent a year. $he stoc#’s beta is 1."! the ris#5free rate is

/ percent! and the mar#et ris# premium is percent. 0hat is the expected

stoc# price eight years from today

a. -1).,

b. -1)/.:7

c. -1''.,*

d. - 7.*,

e. - ,,.7"

Chapter 8 - Page 32


33/79

$C$ model for valuing stock Answer: a Diff: M

1),. $oday is December '1! "))'. $he following information applies to Addison

Airlines?

• After5tax! operating income Q+I$41 5 $6 for the year "))/ is expected

to be -/)) million.

• $he company’s depreciation expense for the year "))/ is expected to be-:) million.

• $he company’s capital expenditures for the year "))/ are expected to be

-17) million.

• 9o change is expected in the company’s net operating wor#ing capital.

• $he company’s free cash flow is expected to grow at a constant rate of

percent per year.

• $he company’s cost of equity is 1/ percent.

• $he company’s 0A88 is 1) percent.

• $he current mar#et &alue of the company’s debt is -1./ billion.

• $he company currently has 1" million shares of stoc# outstanding.

Nsing the free cash flow &aluation method! what should be the company’s

stoc# price today

a. - /)

b. - )

c. - "

d. - :

e. -1))

$C$ model for valuing stock Answer: Diff: M N

11). A stoc# mar#et analyst is e&aluating the common stoc# of Keane In&estment.

(he estimates that the company’s operating income 4+I$6 for the next year

will be -:)) million. Furthermore! she predicts that Keane In&estment

will require -" million in gross capital expenditures 4gross

expenditures represent capital expenditures before deducting depreciation6

next year. In addition! next year’s depreciation expense will be -*

million! and no changes in net operating wor#ing capital are expected.

Free cash flow is expected to grow at a constant annual rate of 7 percent

a year. $he company’s 0A88 is , percent! its cost of equity is 1/

percent! and its before5tax cost of debt is * percent. $he company has

-,)) million of debt! -)) million of preferred stoc#! and has ")) million

outstanding shares of common stoc#. $he firm’s tax rate is /) percent.

Nsing the free cash flow &aluation method! what is the predicted price of

the stoc# today

a. - 11.*

b. - /'.))c. - .)

d. - ,7.''

e. -1):.:'

Chapter 8 - Page 33


34/79

$C$ model for valuing stock Answer: Diff: M N

111. An analyst is trying to estimate the intrinsic &alue of +urress Inc. $he

analyst has estimated the company’s free cash flows for the following

years?

ar#et &alue of debt and preferred stoc# today -)) million.

• 9umber of shares outstanding today ") million.

$he company’s free cash flow is expected to grow at a constant rate of

7 percent a year. $he analyst uses the corporate &alue model approach to

estimate the stoc#’s intrinsic &alue. 0hat is the stoc#’s intrinsic &alue

today

a. - :*.)

b. -"1".)

c. -11).*1d. - ".))

e. - 7".)

Chapter 8 - Page 34


35/79

New equit! and equilirium price Answer: c Diff: M

11'. 9ahanni $reasures 8orporation is planning a new common stoc# issue of fi&e

million shares to fund a new proHect. $he increase in shares will bring

to " million the number of shares outstanding. 9ahanni’s long5term

growth rate is 7 percent! and its current required rate of return is 1".7

percent. $he firm Hust paid a -1.)) di&idend and the stoc# sells for

-17.)7 in the mar#et. 0hen the new equity issue was announced! the firm’s

stoc# price dropped. 9ahanni estimates that the company’s growth rate

will increase to 7. percent with the new proHect! but since the proHect

is ris#ier than a&erage! the firm’s cost of capital will increase to 1'.

percent. Nsing the D8F growth model! what is the change in the

equilibrium stoc# price

a. 5-1.**

b. 5-1.)7

c. 5-).:

d. 5-).77

e. 5-).):

Tough:

Risk and stock price Answer: a Diff: )

11/. Mard Mat 8onstruction’s stoc# is currently selling at an equilibrium price

of -') per share. $he firm has been experiencing a 7 percent annual

growth rate. Cast year’s earnings per share! )! were -/.))! and the

di&idend payout ratio is /) percent. $he ris#5free rate is : percent! and

the mar#et ris# premium is percent. If mar#et ris# 4beta6 increases by

) percent! and all other factors remain constant! by how much will the

stoc# price change 4Mint? Nse four decimal places in your

calculations.6

a. 5- *.''b. O- *.1/

c. 5-1.))

d. 5-1.""

e. O-"".7'

Constant growth stock Answer: c Diff: )

11. hiladelphia 8orporation’s stoc# recently paid a di&idend of -".)) per

share 4D) 2 -"6! and the stoc# is in equilibrium. $he company has a

constant growth rate of percent and a beta equal to 1.. $he required

rate of return on the mar#et is 1 percent! and the ris#5free rate is *

percent. hiladelphia is considering a change in policy that will

increase its beta coefficient to 1.*. If mar#et conditions remain

unchanged! what new constant growth rate will cause hiladelphia’s common

stoc# price to remain unchanged

a. :.:@

b. 1:.'@

c. 7.**@

d. .::@

Chapter 8 - Page 35


36/79

e. 1'."@

#upernormal growth stock Answer: c Diff: )

117. $he Mart >ountain 8ompany has recently disco&ered a new type of #itty

litter that is extremely absorbent. It is expected that the firm will

experience 4beginning now6 an unusually high growth rate 4") percent6

during the period 4' years6 it has exclusi&e rights to the property wherethe raw material used to ma#e this #itty litter is found. Mow5e&er!

beginning with the fourth year the firm’s competition will ha&e access to

the material! and from that time on the firm will achie&e a normal growth

rate of : percent annually. During the rapid growth period! the firm’s

di&idend payout ratio will be relati&ely low 4") percent6 in order to

conser&e funds for rein&estment. Mowe&er! the decrease in growth in the

fourth year will be accompanied by an increase in the di&idend payout to

) percent. Cast year’s earnings were ) 2 -".)) per share! and the

firm’s required return is 1) percent. 0hat should be the current price of

the common stoc#

a. -77.)

b. -:*.,7c. -*1./

d. -71.*:

e. -,'.)

Nonconstant growth stock Answer: Diff: )

11*. 8lub Auto arts’ last di&idend! D)! was -).)! and the company expects to

experience no growth for the next " years. Mowe&er! 8lub will grow at an

annual rate of percent in the third and fourth years! and! beginning

with the fifth year! it should attain a 1) percent growth rate that it

will sustain thereafter. 8lub has a required rate of return of 1"

percent. 0hat should be the price per share of 8lub stoc# at the end

of the second year!"

a. -1,.,:

b. -".):

c. -'1."1

d. -1,./:

e. -"*.

Nonconstant growth stock Answer: e Diff: )

11:. >odular (ystems Inc. Hust paid di&idend D)! and it is expecting both

earnings and di&idends to grow by ) percent in


37/79

e. -".:

Nonconstant growth stock Answer: c Diff: )

11,. A financial analyst has been following Fast (tart Inc.! a new high5growth

company. (he estimates that the current ris#5free rate is 7." percent!

the mar#et ris# premium is percent! and that Fast (tart’s beta is 1.*.

$he current earnings per share 4()6 are -".). $he company has a /)

percent payout ratio. $he analyst estimates that the company’s di&idend

will grow at a rate of " percent this year! ") percent next year! and 1

percent the following year. After three years the di&idend is expected to

grow at a constant rate of * percent a year. $he company is expected to

maintain its current payout ratio. $he analyst belie&es that the stoc# is

fairly priced. 0hat is the current stoc# price

a. -17.1

b. -1*.''

c. -1:.'

d. -1,."

e. -1,.:,

#tock growth rate Answer: Diff: )

1"). >ulroney >otors’ stoc# has a required return of 1) percent. $he stoc#

currently trades at -) per share. $he year5end di&idend! D1! is expected

to be -1.)) per share. After this payment! the di&idend is expected to

grow by " percent per year for the next three years. $hat is! D/ 2

-1.))41."6' 2 -1.,'1". After t 2 /! the di&idend is expected to grow

at a constant rate of ; percent per year fore&er. 0hat is the stoc#’s

expected constant growth rate after t 2 / In other words! what is ;

a. ./*@

b. 7.:*@

c. 7.,:@d. :.))@

e. :."*@

Preferred stock value Answer: d Diff: )

1"1. Assume that you would li#e to purchase 1)) shares of preferred stoc# that

pays an annual di&idend of -7 per share. Mowe&er! you ha&e limited

resources now! so you cannot afford the purchase price. In fact! the best

that you can do now is to in&est your money in a ban# account earning a

simple interest rate of 7 percent! but where interest is compounded daily

4assume a '75day year6. +ecause the preferred stoc# is ris#ier! it has a

required annual rate of return of 1" percent. 4Assume that this rate will

remain constant o&er the next years.6 For you to be able to purchase

this stoc# at the end of years! how much must you deposit in your ban#

account today! at t 2 )

a. -"!,:.))

b. -/!",1."'

c. -'!1':."

d. -'!*)/.1:

Chapter 8 - Page 37


38/79

e. -/!:'1."$irm value Answer: c Diff: )

1"". Assume an all equity firm has been growing at a 1 percent annual rate and

is expected to continue to do so for ' more years. At that time! growth

is expected to slow to a constant / percent rate. $he firm maintains a ')

percent payout ratio! and this year’s retained earnings net of di&idends

were -1./ million. $he firm’s beta is 1."! the ris#5free rate is :

percent! and the mar#et ris# premium is / percent. If the mar#et is in

equilibrium! what is the mar#et &alue of the firm’s common equity 41

million shares outstanding6

a. - 7./1 million

b. -1".,7 million

c. - ,.1* million

d. -1).7 million

e. - *.'" million

Multiple Part:

(The following information applies to the next two problems.)

+ridges S Associates’ stoc# is expected to pay a -).* per5share di&idend at the

end of the year. $he di&idend is expected to grow " percent the next year and

' percent the following year. After t 2 '! the di&idend is expected to grow at

a constant rate of 7 percent a year. $he company’s cost of common equity is 1)

percent and it is expected to remain constant.

#tock price%%nonconstant growth Answer: Diff: M N

1"'. 0hat is the expected price of the stoc# today

a. -1:.*

b. -"*.71

c. -').**

d. -'/.)

e. -'.)

$uture stock price%%constant growth Answer: c Diff: M N

1"/. 0hat is the expected price of the stoc# 1) years from today

a. -/*.:

b. -/,./

c. -)./'

d. -'./7

e. -.1)

Chapter 8 - Page 38


39/79


An analyst has put together the following spreadsheet to estimate the intrinsic

&alue of the stoc# of Rangan 8ompany 4in millions of dollars6?

t 2 1 t 2 " t 2 '

(ales -'!))) -'!7)) -/!))

9=A$ )) 7)) *)9et in&estment in operating capitalT ')) /)) ))

T9et in&estment in operating capital 2 8apital expenditures O 8hanges in net

operating capital L Depreciation.

After


40/79


An analyst is estimating the intrinsic &alue of the stoc# of ;a&ier 8ompany.

$he analyst estimates that the stoc# will pay a di&idend of -1.* a share at the

end of the year 4that is!1DJ 2 -1.*6. $he di&idend is expected to remain at

this le&el until / years from now 4that is!"

DJ

2 'DJ 2

/

DJ 2 -1.*6. After

this time! the di&idend is expected to grow fore&er at a constant rate of 7

percent a year 4that is!.DJ 2 -1.:6. $he stoc# has a required rate of

return of 1' percent.

Nonconstant growth stock Answer: Diff: M N

1"*. 0hat is the stoc#’s intrinsic &alue today 4$hat is! what is)J 6

a. -").,'

b. -"1./7

c. -"".,1

d. -".))

e. -"7.)

$uture stock price%%nonconstant growth Answer: Diff: M N

1":. Assume that the forecasted di&idends and the required return are the same

one year from now! as those forecasted today. 0hat is the expected

intrinsic &alue of the stoc# one year from now! Hust after the di&idendhas been paid at t 2 1 4$hat is! what is

1J 6

a. -").,'

b. -"".)

c. -"'.*

d. -"/.*

e. -"*.1:

Chapter 8 - Page 40


41/79

Chapter 8 - Page 41

CHAPTER 8

ANSWERS AND SO!T"ONS


42/79

1* Required return Answer: e Diff: E

"* Required return Answer: d Diff: E

'* Required return Answer: a Diff: E

$he total return is made up of a di&idend yield and capital gains yield. For

(toc# A! the total required return is 1) percent and its capital gains yield

4g6 is * percent. $herefore! A’s di&idend yield must be ' percent. For (toc#

+! the required return is 1" percent and its capital gains yield 4g6 is ,

percent. $herefore! +’s di&idend yield must also be ' percent. $herefore!

statement a is true. (tatement b is false. >ar#et efficiency Hust means that

all of the #nown information is already reflected in the price! and you can’t

earn abo&e the required return. $his would depend on betas! di&idends! and the

number of shares outstanding. 0e don’t ha&e any of that information.

(tatement c is false. $he expected returns of the two stoc#s would be the same

only if they had the same betas.

/* Constant growth model Answer: a Diff: E

(tatement a is trueB the other statements are false. $he constant growth model

is not appropriate for stoc# &aluation in the absence of a constant growth

rate. If the required rate of return differs for the two firms due to ris#

differences! then the firms’ stoc# prices would differ.

* Constant growth model Answer: a Diff: E

(tatement a is trueB the other statements are false. If a stoc#’s required

return is 1" percent and its capital gains yield is percent! then its

di&idend yield is 1"@ 5 @ 2 *@. $he expected future di&idends should be

discounted at the required rate of return.

7* Constant growth model Answer: c Diff: E

(tatement c is trueB the others are false. (tatement a would be true only if

the di&idend yield were %ero. (tatement b is falseB we’&e been gi&en no

information about the di&idend yield. (tatement c is trueB the constant rate

at which di&idends are expected to grow is also the expected growth rate of the

stoc#’s price.

** Constant growth model Answer: e Diff: E

(tatement a is false? ) 2 D134#s 5 g6. g is different for the two stoc#s! butthe required return and expected di&idend are the same! so the prices will be

different also. (tatement b is false? #s 2 D13) O g. A has a higher g! so its

di&idend yield must be lower because the firms ha&e the same required rate of

return. (tatement c is false. $herefore! statement e is the correct answer.

:* Constant growth model Answer: c Diff: E N

$he correct answer is statement c.

For (toc# ;! #s 2 D13) O g


43/79

).1" 2 D13) O ).)7! or D13) 2 ).)7.

For (toc#

).1) 2 D13) O ).)/! or D13) 2 ).)7.

(o! both (toc# ; and (toc# < ha&e the same di&idend yield. (o! statements a and b

are incorrect. $hat also ma#es statements d and e incorrect. (ince both stoc#s ;

and < ha&e the same price today! and (toc# ; has a higher di&idend growth rate than

(toc#

,* Constant growth model Answer: e Diff: E N

$he correct answer is statement e. At a price of -)! #s 2 D13) O g 2

-'.))3-) O ).)7 2 1"@. (o! statement a is correct.1)J 2 -)41.)761) 2

-:,./. (o! statement b is also correct. D13) 2 -'.))3-).)) 2 7@! so

statement c is correct. $hus! statement e is the correct choice.

1)* Constant growth model Answer: e Diff: E

If (toc# ; has a required return of 1" percent and a di&idend yield of

percent! we can calculate its growth rate?

#s 2 D13) O g1"@ 2 @ O g

*@ 2 g.

If (toc# < has a required return of 1) percent and a di&idend yield of

' percent! we can calculate its growth rate?

#s 2 D13) O g

1)@ 2 '@ O g

*@ 2 g.

(ince both stoc#s ha&e the same price and (toc# ; has a higher di&idend yield than

(toc#

0e Hust showed abo&e! that both stoc#s ha&e the same growth rate! so statement b

must be false. =ne year from now! the stoc#s will both trade at the same price.$hey are starting at the same price today! and will be growing at the same rate

this year! so they will end up with the same stoc# price one year from now.

$herefore! statement c must also be true. (ince both statements a and c are true!

the correct choice is statement e.

11* Constant growth model and CAPM Answer: a Diff: E N

$he correct answer is statement a. From the information gi&en and the 8A>

equation! we #now that (toc# A’s and (toc# +’s required returns are 1".,@ and

11.*@! respecti&ely. $he required return is equal to a di&idend yield and a

capital gains yield. (ince these are constant growth stoc#s! their capital

gains yields are equi&alent to their di&idend growth rates of *@. $herefore!

the di&idend yields for (toc# A and (toc# + are .,@ and /.*@! respecti&ely.

(tatement b is incorrectB we cannot determine which stoc# has the higher pricewithout #nowing their expected di&idends. (tatement c is incorrectB from the

answer gi&en for statement a! we #now that (toc# +’s di&idend yield doesn’t

equal its expected di&idend growth rate.

1"* Miscellaneous issues Answer: c Diff: E

(tatement c is trueB the others are false. $wo classes of common stoc# can

ha&e different &oting rights! as well as pay different di&idends.

An I= occurs when a firm goes public for the first time. (tatement c is the

exact definition of a preempti&e right.


44/79

1'

* Preemptive right Answer: Diff: E

1/* Classified stock Answer: e Diff: E

1* Efficient markets h!pothesis Answer: e Diff: E

(tatements a through d are falseB therefore! statement e is true. (tatement a

is false. (trong5form efficiency states that current mar#et prices reflect all

pertinent information! whether publicly a&ailable or pri&ately held. If it

holds! e&en insiders would find it impossible to earn abnormal returns in the

stoc# mar#et. (tatement b is falseB this describes semistrong5form efficiency.

(tatement c is falseB some in&estors may be able to analy%e and react more

quic#ly than others to releases of new information. Mowe&er! the buy5sell

actions of those in&estors quic#ly bring mar#et prices into equilibrium.

17* Efficient markets h!pothesis Answer: d Diff: E

(toc#s are usually ris#ier than bonds and should ha&e higher expected returns.

$herefore! statement a is false. In equilibrium! stoc#s with more mar#et ris#

should ha&e higher expected returns than stoc#s with less mar#et ris#.

$herefore! statement b is false. $he semistrong form of mar#et efficiency says

that all publicly a&ailable information! including past price history! is

already accounted for in the stoc#’s price. $herefore! statement c is false.

Remember! when trying to find the price of a stoc#! we discount all future cash

flows by the required return. If the price is equal to the present &alue of

those cash flows! then the 9P of the stoc# must be equal to ). $herefore!

statement d is true. 9et present &alue is stated in dollars and the required

return is stated as a percent. It is impossible for the two to equal each

other. $herefore! statement e is false.1** Efficient markets h!pothesis Answer: e Diff: E

(tatement a is falseB ris#ier securities ha&e higher required returns.

(tatement b is false for the same reason as statement a. (tatement c is falseBsemistrong5form efficiency says that you cannot ma#e abnormal profits by

trading off publicly a&ailable information. (o statement e is the correct

answer.

1:* Efficient markets h!pothesis Answer: e Diff: E

0ea#5form efficiency means that you cannot profit from recent trends in stoc#

prices 4that is! technical analysis doesn’t wor#6. $herefore! statement a must

be false. (emistrong5form efficiency means that all public information is

already accounted for in the stoc# price. +ecause bonds and stoc#s ha&e

different ris# le&els and tax implications! there is no reason to expect them

to ha&e the same return. $herefore! statement b must be false. (imilarly!

because different stoc#s ha&e different ris# le&els! there is no reason toexpect all stoc#s to ha&e the same return. $herefore! statement c is also

false. $he correct choice is statement e.

1,* Efficient markets h!pothesis Answer: c Diff: E

(tatement c is trueB the other statements are false. (emistrong5form mar#et

efficiency implies that only public information! not pri&ate! is rapidly

incorporated into stoc# prices. >ar#ets can be efficient yet still price

securities differently depending on their ris#s.

")


45/79

* Efficient markets h!pothesis Answer: a Diff: E

"1* Efficient markets h!pothesis Answer: e Diff: E N

$he correct answer is statement e. If prices rapidly reflect all a&ailable

public information! then the mar#et is semistrong5form efficient not wea#5form

efficient. $herefore! statement a is incorrect. If the mar#et is wea#5form

efficient! then you cannot beat the mar#et by using technical analysis or

charting. $herefore! statement b is incorrect. Different stoc#s will ha&e

different ris# and will ha&e different required and expected returns! so

statement c is incorrect.

""* Efficient markets h!pothesis Answer: a Diff: E

(tatement a is trueB the other statements are false. Mistorical information

cannot be used to beat the mar#et under wea#5form efficiency. ublic

information cannot be used to beat the mar#et under semistrong5form efficiency.

"'

* Preferred stock concepts Answer: e Diff: E

"/* Preferred stock concepts Answer: e Diff: E

+oth statements a and b are trueB therefore! statement e is the correct choice.

*) percent of di&idends recei&ed! not paid out! are tax deductible."* Common stock concepts Answer: d Diff: E

(tatements b and c are trueB therefore! statement d is the correct choice. A

greater proportion of common stoc# in the capital structure increases the

li#elihood of a ta#eo&er bid.

"7* Common stock concepts Answer: e Diff: E

0e don’t #now anything about the di&idends of either stoc#. (toc# < could ha&e

a di&idend yield of ) percent and a capital gains yield of 1" percent! while

(toc# ; has a di&idend yield of 1) percent and a capital gains yield of )

percent. $herefore! statement a is false. If the two stoc#s ha&e the same

di&idend yield! (toc# < must ha&e a higher expected capital gains yield than ;

because < has the higher required return. $herefore! statement b is false.

Remember the D8F formula? ) 2 D134#s 5 g6. If D1 and g are the same! and we

#now that < has a higher required return than ;! then


46/79

(tatements a and b are both false because the required return consists of both

a di&idend yield 4D13)6 and a growth rate. (tatements a and b don’t mention

the growth rate. (tatement c is true because if the required return for (toc#

A is higher than that of (toc# +! and if the di&idend yield for (toc# A is

lower than (toc# +’s! the growth rate for (toc# A must be higher to offset

this. (tatement d is not necessarily true because the growth rate could go

either way depending upon how high the di&idend yield is. (tatement e is also

not necessarily true.

')* Market equilirium Answer: Diff: E N

$he correct answer is statement b. $he reali%ed return is an historical

return. It is what has already happened in the past. $here is no reason that

the expected return in the future should equal the return it has reali%ed in

the past. $herefore! statement a is incorrect. If the expected return does

not equal the required return! then mar#ets are not in equilibrium. If you are

expecting a higher return than you require 4gi&en the le&el of ris#6 for a

stoc#! then the stoc# will be a bargain.E


47/79

'7* Market equilirium Answer: a Diff: M

'** "wnership and going pulic Answer: c Diff: M

':* Dividend !ield and g Answer: Diff: M

(tatement b is trueB the other statements are false. $he stoc#’s required

return must equal the sum of its expected di&idend yield and constant growth

rate. A stoc#’s di&idend yield can exceed the expected growth rate.',* Constant growth model Answer: d Diff: M

(tatement d is trueB the other statements are false. #s 2 Di&idend yield O

8apital gains. 1/@ 2 Di&idend yield O :@B therefore! Di&idend yield 2 7@.

Di&idend yield 2 Di&idend3riceB Di&idend 2 ).)7 × -) 2 -'. Future stoc#

price 2 -) × 1.): 2 -/.

/)

* Preferred stock value Answer: d Diff: E

Pp 2 Dp3#p 2 -3).") 2 -".

/1

* Preferred stock value Answer: d Diff: E

$he di&idend is calculated as 1)@ × -1") 2 -1". 0e #now that the cost of

preferred stoc# is equal to the di&idend di&ided by the stoc# price or :@ 2

-1"3rice. (ol&e this expression for rice 2 -1). 49ote? 9on5partici5pating

preferred stoc#holders are entitled to Hust the stated di&idend rate. $here is

no growth in the di&idend.6

/"* Preferred stock !ield Answer: c Diff: E

Annual di&idend 2 -".)4/6 2 -1).

#p 2 Dp3Pp 2 -1)3-) 2 ).") 2 ")@./'

* Preferred stock !ield Answer: a Diff: E

Annual di&idend 2 -).)4/6 2 -".)).

#p 2 Dp3Pp 2 -".))3-").)) 2 ).1) 2 1)@.

//

* #tock price Answer: d Diff: E

) 1 " $ 2 )B FP 2 1,.". =utput? P 2 5-11:.'.

) 2 -11:.'.

/* $uture stock price%%constant growth Answer: d Diff: E

$he stoc# price will grow at * percent for / years! -" × 41.)*6/ 2 -'".**.


48/79

/7 * $uture stock price%%constant growth

Answer: Diff: E

$he stoc# price today is calculated as?

-/34).1" 5 ).):6 2 -1)). If the growth rate is : percent! the price in

: years will be? -1)) × 41.):6: 2 -1:.),.

/** $uture stock price%%constant growth Answer: a Diff: E

(tep 1? Find g?

) 2 D134#s 5 g6

-") 2 -"34).1 5 g6

g 2 @.

(tep "? Find at t 2 *?

J*

2 )41 O g6*

J * 2 -")41.)6*

J * 2 -":.1/ ≈ -":.

/:* $uture stock price%%constant growth Answer: a Diff: E

(tep 1? Determine the constant growth rate! g?

#s 2 D13) O g

,@ 2 -"3-/) O g

).), 2 ).) O g

).)/ 2 g.

(tep "? Determine the expected price of the stoc# years from today?

.

2 ) × 41 O g6n

2 -/) × 41.)/6

2 -/) × 1."177

2 -/:.7*.

/,* $uture stock price%%constant growth Answer: e Diff: E N

$he price today! ) 2g#

DJ

s

1

−

2)*.)1".)

).)-

−

2 -1).)).

(ince this is a constant growth stoc#! its price will grow at the same rate as

di&idends. (o!/J 2 )41.)*6

/ 2 -1).))41.)*6/ 2 -1'.1): ≈ -1'.11.

)* Constant growth stock Answer: Diff: E

#s 2 D13) O g

g 2 #s 5 D13)g 2 ).11 5 -13-") 2 ).)7 2 7@.

1* Constant growth stock Answer: a Diff: E


49/79

) 2).15).1,

6-".))41.1 2 -*.).

"* Constant growth stock Answer: e Diff: E

$he required rate of return on the stoc#? @ O 4,@ 5 @61.' 2 1)."@.

D1 2 -"./) × 1.)7 2 -".//.

$he price of the stoc# today is -".//34).1)" 5 ).)76 2 -7).*.

'* Constant growth stock Answer: c Diff: E

) 2 D134#s 5 g6

-') 2 -'34).17 L g6

-/.: 5 -')g 2 -'

-1.: 2 -')g

g 2 7@.

/* Constant growth stock Answer: d Diff: E

0e #now that ) 2 D13#s 5 g6 and we ha&e all the information except D 1! so we

input the data into this equation.

-') 2 D134).1) 5 ).)*6-') 2 ''.''D1

D1 2 -).,).

* Constant growth stock Answer: Diff: E

(tep 1? 8alculate the price of the stoc# today! since it is a constant growth

stoc#.

D1 2 -".))B #s 2 ).),B g 2 ).).

) 2 D134#s 5 g6

2 -".))34).), 5 ).)6

2 -).

(tep "? Determine the price of the stoc# fi&e years from today?

. 2 -) × 41.)6 2 -7'.:1.

7* Constant growth stock Answer: d Diff: E

(tep 1? Nsing the ordon constant growth model! calculate today’s price?

) 2 D134#s 5 g6

2 -).7)34).1" 5 ).)*6

2 -1".)).

(tep "? 8alculate the price of the stoc# years from today! assuming

g 2 *@ per year?

.J 2 ) × 41.)*6

2 -1".)) × 41.)*6

2 -17.:'.

** Constant growth stock Answer: Diff: E N


50/79

$his is a constant growth stoc#! so you can use the ordon constant growth

model to calculate today’s price. =nce you ha&e today’s price! you can find

the price in 1) years.

(tep 1? Find the stoc#’s current price.

) 2 D134#s 5 g6

2 -)./34).11 5 ).)/6

2 -7./":7.

(tep "? Find the stoc#’s price in 1) years! gi&en its current stoc# price.

1)J 2 )41 O g6

n

2 -7./":741.)/61)

2 -,.".

:* Nonconstant growth stock Answer: d Diff: E

) 1 " '

stock valuation.doc

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