CHAPTER 7—VALUATION OF STOCKS AND CORPORATIONS
MULTIPLE CHOICE
17. Which of the following statements is CORRECT?
a.
If a stock has a required rate of
return rs = 12% and its dividend is
expected to grow at a constant rate
of 5%, this implies that the stock's
dividend yield is also 5%.
b.
The stock valuation model, P0 = D1/
(rs g), can be used to value firms
whose dividends are expected to
decline at a constant rate, i.e., to
grow at a negative rate.
c.
The price of a stock is the present
value of all expected future
dividends, discounted at the
dividend growth rate.
d.
The constant growth model cannot
be used for a zero growth stock,
where the dividend is expected to
remain constant over time.
e.
The constant growth model is often
appropriate for evaluating start-up
companies that do not have a stable
history of growth but are expected
to reach stable growth within the
next few years.
ANS: B
PTS: 1
DIF: Difficulty: Easy
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Constant growth model
KEY: Bloom’s:
Comprehension
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
18. If a firm's expected growth rate increased then its required rate of return would
a.
decrease.
b.
fluctuate less than before.
c.
fluctuate more than before.
d.
possibly increase, possibly
decrease, or possibly remain
constant.
e.
increase.
ANS: D
OBJ: LO: 7-5
bonds
LOC: TBA
Comprehension
PTS: 1
DIF: Difficulty: Easy
NAT: BUSPROG: Analytic
TOP: Required return
STA: DISC: Stocks and
KEY: Bloom’s:
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
19. You, in analyzing a stock, find that its expected return exceeds its required return.
This suggests that you think
a.
the stock should be sold.
b.
the stock is a good buy.
c.
management is probably not trying
to maximize the price per share.
d.
dividends are not likely to be
declared.
e.
the stock is experiencing
supernormal growth.
ANS: B
PTS: 1
DIF: Difficulty: Easy
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Required return
KEY: Bloom’s:
Comprehension
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
20. The preemptive right is important to shareholders because it
a.
will result in higher dividends per
share.
b.
is included in every corporate
charter.
c.
protects the current shareholders
against a dilution of their ownership
interests.
d.
protects bondholders, and thus
enables the firm to issue debt with a
relatively low interest rate.
e.
allows managers to buy additional
shares below the current market
price.
ANS: C
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-1
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Preemptive right
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
21. Companies can issue different classes of common stock. Which of the following
statements concerning stock classes is CORRECT?
a.
All common stocks, regardless of
class, must have the same voting
rights.
b.
All firms have several classes of
common stock.
c.
All common stock, regardless of
d.
e.
class, must pay the same dividend.
Some class or classes of common
stock are entitled to more votes per
share than other classes.
All common stocks fall into one of
three classes: A, B, and C.
ANS: D
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-2
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Classified stock
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
22. Which of the following statements is CORRECT?
a.
Two firms with the same expected
dividend and growth rates must also
have the same stock price.
b.
It is appropriate to use the constant
growth model to estimate a stock's
value even if its growth rate is never
expected to become constant.
c.
If a stock has a required rate of
return rs = 12%, and if its dividend
is expected to grow at a constant
rate of 5%, this implies that the
stock's dividend yield is also 5%.
d.
The price of a stock is the present
value of all expected future
dividends, discounted at the
dividend growth rate.
e.
The constant growth model takes
into consideration the capital gains
investors expect to earn on a stock.
ANS: E
Statement e is true, because the expected growth rate is also the expected
capital gains yield. All the other statements are false.
PTS:
NAT:
LOC:
MSC:
NOT:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Constant growth model
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
Question may require calculations to find the correct answer.
23. A stock is expected to pay a year-end dividend of $2.00, i.e., D 1 = $2.00. The
dividend is expected to decline at a rate of 5% a year forever (g = 5%). If the
company is in equilibrium and its expected and required rate of return is 15%,
which of the following statements is CORRECT?
a.
The company's dividend yield 5
years from now is expected to be
10%.
b.
The constant growth model cannot
be used because the growth rate is
negative.
The company's expected capital
gains yield is 5%.
The company's expected stock price
at the beginning of next year is
$9.50.
The company's current stock price is
$20.
c.
d.
e.
ANS: D
Note that P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5%
each year, so P1 must be $10(0.95) = $9.50. Therefore, answer d is correct, while
the others are all false.
PTS:
NAT:
LOC:
MSC:
NOT:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Declining constant growth
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
Question may require calculations to find the correct answer.
24. If a stock's dividend is expected to grow at a constant rate of 5% a year, which of
the following statements is CORRECT? The stock is in equilibrium.
a.
The stock's dividend yield is 5%.
b.
The price of the stock is expected to
decline in the future.
c.
The stock's required return must be
equal to or less than 5%.
d.
The stock's price one year from now
is expected to be 5% above the
current price.
e.
The expected return on the stock is
5% a year.
ANS: D
Statement d is true, because the stock price is expected to grow at the dividend
growth rate.
PTS:
NAT:
LOC:
MSC:
NOT:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Constant growth stock
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
Question may require calculations to find the correct answer.
25. Stocks A and B have the following data. Assuming the stock market is efficient
and the stocks are in equilibrium, which of the following statements is CORRECT?
Required return
Market price
Expected growth
A
10%
$25
7%
B
12%
$40
9%
a.
b.
c.
d.
e.
These two stocks must have the
same dividend yield.
These two stocks should have the
same expected return.
These two stocks must have the
same expected capital gains yield.
These two stocks must have the
same expected year-end dividend.
These two stocks should have the
same price.
ANS: A
The following calculations show that answer a is correct. The others are all wrong.
Expected return
Expected growth
Dividend yield
A
10%
7%
3%
B
12%
9%
3%
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
26. Stocks A and B have the following data. Assuming the stock market is efficient
and the stocks are in equilibrium, which of the following statements is CORRECT?
Price
Expected growth
Expected return
a.
b.
c.
d.
e.
A
$25
7%
10%
B
$40
9%
12%
The two stocks could not be in
equilibrium with the numbers given
in the question.
A's expected dividend is $0.50.
B's expected dividend is $0.75.
A's expected dividend is $0.75 and
B's expected dividend is $1.20.
The two stocks should have the
same expected dividend.
ANS: D
The following calculations show that answer d is correct. The others are all wrong.
Price
Expected growth
Expected return
A
$25
7%
10%
B
$40
9%
12%
A = P0 = D1/(r g) = D1 = P0(r) P0(g) = $0.75
B = P0 = D1/(r g) = D1 = P0(r) P0(g) = $1.20
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
27. Stocks A and B have the following data. Assuming the stock market is efficient
and the stocks are in equilibrium, which of the following statements is CORRECT?
Price
Expected growth
(constant)
Required return
a.
b.
c.
d.
e.
A
$25
10%
B
$25
5%
15%
15%
Stock A has a higher dividend yield
than Stock B.
Currently the two stocks have the
same price, but over time Stock B's
price will pass that of A.
Since Stock A's growth rate is twice
that of Stock B, Stock A's future
dividends will always be twice as
high as Stock B's.
The two stocks should not sell at the
same price. If their prices are equal,
then a disequilibrium must exist.
Stock A's expected dividend at t = 1
is only half that of Stock B.
ANS: E
Statement e is correct, because if both stocks have the same price and the same
required return, and A's growth rate is twice that of B, then A's dividend and
dividend yield must be half that of B. This point is illustrated with the following
example.
Price
g
r
Div. Yield = r g =
D1 = P(Div Yield) =
A
$25
10%
15%
5%
$1.25
B
$25
5%
15%
10%
$2.50
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
28. Stocks X and Y have the following data. Assuming the stock market is efficient
and the stocks are in equilibrium, which of the following statements is CORRECT?
Price
Expected growth
(constant)
Required return
a.
b.
c.
d.
e.
X
$30
6%
Y
$30
4%
12%
10%
Stock Y has a higher dividend yield
than Stock X.
One year from now, Stock X's price
is expected to be higher than Stock
Y's price.
Stock X has the higher expected
year-end dividend.
Stock Y has a higher capital gains
yield.
Stock X has a higher dividend yield
than Stock Y.
ANS: B
The correct answer is statement b. Both prices are currently the same, but X's
price should grow at 6% vs. 4% for Y, so X's price should be higher a year from
now.
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
29. Stock X has the following data. Assuming the stock market is efficient and the
stock is in equilibrium, which of the following statements is CORRECT?
Expected dividend, D1
Current Price, P0
Expected constant growth rate
a.
b.
c.
d.
$3.00
$50
6.0%
The stock's expected dividend yield
and growth rate are equal.
The stock's expected dividend yield
is 5%.
The stock's expected capital gains
yield is 5%.
The stock's expected price 10 years
from now is $100.00.
e.
The stock's required return is 10%.
ANS: A
The correct answer choice is a. One could quickly calculate the dividend yield and
see that it equals the growth rate, but here are some numbers that provide more
information.
D1
P0
g
$3.00 D1/P0
$50.00 rX
6.0%
6.0%
12.0%
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
30. Stocks X and Y have the following data. Assuming the stock market is efficient
and the stocks are in equilibrium, which of the following statements is CORRECT?
Price
Expected dividend yield
Required return
a.
b.
c.
d.
e.
ANS: A
Dividend = Yield Price:
X
$25
5%
12%
Y
$25
3%
10%
Stock X pays a higher dividend per
share than Stock Y.
One year from now, Stock X should
have the higher price.
Stock Y has a lower expected
growth rate than Stock X.
Stock Y has the higher expected
capital gains yield.
Stock Y pays a higher dividend per
share than Stock X.
X dividend = $1.25
Y dividend = $0.75
Stock X has a dividend yield of 5% versus a yield of 3% for Y. Since they both
have the same stock price, X must pay a higher dividend.
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
31. Merrell Enterprises' stock has an expected return of 14%. The stock's dividend is
expected to grow at a constant rate of 8%, and it currently sells for $50 a share.
Which of the following statements is CORRECT?
a.
The stock's dividend yield is 8%.
b.
The current dividend per share is
$4.00.
c.
The stock price is expected to be
$54 a share one year from now.
d.
The stock price is expected to be
$57 a share one year from now.
e.
The stock's dividend yield is 7%.
ANS: C
P1 = P0(1 + g) = $54. Therefore, c is correct. All the other answers are false. P 1 =
$54.00.
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Expected and required returns
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
32. Stocks A and B have the same price and are in equilibrium, but Stock A has the
higher required rate of return. Which of the following statements is CORRECT?
a.
Stock B must have a higher dividend
yield than Stock A.
b.
Stock A must have a higher dividend
yield than Stock B.
c.
If Stock A has a higher dividend
yield than Stock B, its expected
capital gains yield must be lower
than Stock B's.
d.
Stock A must have both a higher
dividend yield and a higher capital
gains yield than Stock B.
e.
If Stock A has a lower dividend yield
than Stock B, its expected capital
gains yield must be higher than
Stock B's.
ANS: E
Statement e is true, because if the required return for Stock A is higher than that
of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the
growth rate for Stock A must be higher to offset this.
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Dividend yield and g
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
33. Two constant growth stocks are in equilibrium, have the same price, and have the
same required rate of return. Which of the following statements is CORRECT?
a.
b.
c.
d.
e.
If one stock has a higher dividend
yield, it must also have a lower
dividend growth rate.
If one stock has a higher dividend
yield, it must also have a higher
dividend growth rate.
The two stocks must have the same
dividend growth rate.
The two stocks must have the same
dividend yield.
The two stocks must have the same
dividend per share.
ANS: A
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Dividend yield and g
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
34. Which of the following statements is CORRECT, assuming stocks are in
equilibrium?
a.
Assume that the required return on
a given stock is 13%. If the stock's
dividend is growing at a constant
rate of 5%, its expected dividend
yield is 5% as well.
b.
A stock's dividend yield can never
exceed its expected growth rate.
c.
A required condition for one to use
the constant growth model is that
the stock's expected growth rate
exceeds its required rate of return.
d.
Other things held constant, the
higher a company's beta coefficient,
the lower its required rate of return.
e.
The dividend yield on a constant
growth stock must equal its
expected total return minus its
expected capital gains yield.
ANS: E
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Dividend yield and g
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
35. Which of the following statements is NOT CORRECT?
a.
The corporate valuation model
discounts free cash flows by the
b.
c.
d.
e.
ANS:
OBJ:
STA:
LOC:
MSC:
required return on equity.
The corporate valuation model can
be used to find the value of a
division.
An important step in applying the
corporate valuation model is
forecasting the firm's pro forma
financial statements.
Free cash flows are assumed to
grow at a constant rate beyond a
specified date in order to find the
horizon, or terminal, value.
The corporate valuation model can
be used both for companies that
pay dividends and those that do not
pay dividends.
A
PTS: 1
DIF: Difficulty: Moderate
LO: 7-7
NAT: BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
36. Which of the following statements is CORRECT?
a.
The preferred stock of a given firm
is generally less risky to investors
than the same firm's common stock.
b.
Corporations cannot buy the
preferred stocks of other
corporations.
c.
Preferred dividends are not
generally cumulative.
d.
A big advantage of preferred stock
is that dividends on preferred stocks
are tax deductible by the issuing
corporation.
e.
Preferred stockholders have a
priority over bondholders in the
event of bankruptcy to the income,
but not to the proceeds in a
liquidation.
ANS: A
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-9
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Preferred stock concepts
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
37. Which of the following statements is CORRECT?
a.
Preferred stock is normally expected
to provide steadier, more reliable
income to investors than the same
b.
c.
d.
e.
firm's common stock, and, as a
result, the expected after-tax yield
on the preferred is lower than the
after-tax expected return on the
common stock.
The preemptive right is a provision
in all corporate charters that gives
preferred stockholders the right to
purchase (on a pro rata basis) new
issues of preferred stock.
One of the disadvantages to a
corporation of owning preferred
stock is that 70% of the dividends
received represent taxable income
to the corporate recipient, whereas
interest income earned on bonds
would be tax free.
One of the advantages to financing
with preferred stock is that 70% of
the dividends paid out are tax
deductible to the issuer.
A major disadvantage of financing
with preferred stock is that preferred
stockholders typically have
supernormal voting rights.
ANS: A
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-9
NAT: BUSPROG: Analytic
STA: DISC: Stocks and
bonds
LOC: TBA
TOP: Preferred stock concepts
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
38. Which of the following statements is CORRECT?
a.
The preemptive right gives
stockholders the right to approve or
disapprove of a merger between
their company and some other
company.
b.
The preemptive right is a provision
in the corporate charter that gives
common stockholders the right to
purchase (on a pro rata basis) new
issues of the firm's common stock.
c.
The stock valuation model, P0 = D1/
(rs g), cannot be used for firms that
have negative growth rates.
d.
The stock valuation model, P0 = D1/
(rs g), can be used only for firms
whose growth rates exceed their
required returns.
e.
If a company has two classes of
common stock, Class A and Class B,
the stocks may pay different
dividends, but under all state
charters the two classes must have
the same voting rights.
ANS: B
Statement a is simply false. Statement b is true. Statements c and d are false,
because the constant growth model can be used anytime as long as the constant
growth rate is less than the required return (even if the growth rate is negative).
Statement e is falsea number of companies have different classes of stock with
different voting rights.
PTS:
NAT:
LOC:
MSC:
NOT:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Common stock concepts
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
Question may require calculations to find the correct answer.
39. The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the
following statements is CORRECT?
a.
If Stock Y and Stock X have the
same dividend yield, then Stock Y
must have a lower expected capital
gains yield than Stock X.
b.
If Stock X and Stock Y have the
same current dividend and the same
expected dividend growth rate, then
Stock Y must sell for a higher price.
c.
The stocks must sell for the same
price.
d.
Stock Y must have a higher dividend
yield than Stock X.
e.
If the market is in equilibrium, and if
Stock Y has the lower expected
dividend yield, then it must have
the higher expected growth rate.
ANS: E
Since X has the lower required return, if Y has a lower dividend yield it must have
a higher expected growth rate.
PTS:
NAT:
LOC:
MSC:
NOT:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Common stock concepts
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
Question may require calculations to find the correct answer.
40. Stocks A and B have the following data. The market risk premium is 6.0% and the
risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in
equilibrium, which of the following statements is CORRECT?
A
B
Beta
Constant growth rate
1.10
7.00%
a.
0.90
7.00%
Stock A must have a higher dividend
yield than Stock B.
Stock B's dividend yield equals its
expected dividend growth rate.
Stock B must have the higher
required return.
Stock B could have the higher
expected return.
Stock A must have a higher stock
price than Stock B.
b.
c.
d.
e.
ANS: A
Statement a is true, because Stock A has a higher required return but the stocks
have the same growth rate, so Stock A must have the higher dividend yield. Here
are some calculations to demonstrate the point.
A
B
rRF
6.40%
6.40%
A
Div.
Yld.
D1/P0
+
7.00%
=
B
D1/P0
+
7.00%
=
+
+
beta
1.10
0.90


g
RPM
6.00%
6.00%
=
=
rStock
13.00%
11.80%
rStock
13.00% D1/P0 =
r g =
6.00%
11.80% D1/P0 =
r g =
4.80%
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Constant growth model: CAPM
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
NOT: Question may require calculations to find the correct answer.
41. A stock is expected to pay a dividend of $0.75 at the end of the year. The
required rate of return is rs = 10.5%, and the expected constant growth rate is g
= 6.4%. What is the stock's current price?
a.
$17.39
b.
$17.84
c.
$18.29
d.
$18.75
e.
$19.22
ANS: C
D1
rs
$0.75
10.5%
g
P0 = D1/(rs g)
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Constant growth valuation
TYPE: Multiple Choice: Problem
6.4%
$18.29
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Application
42. A stock just paid a dividend of D0 = $1.50. The required rate of return is rs =
10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
a.
$23.11
b.
$23.70
c.
$24.31
d.
$24.93
e.
$25.57
ANS: E
D0
rs
g
D1 = D0(1 + g) =
P0 = D1/(rs g)
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Constant growth valuation
TYPE: Multiple Choice: Problem
$1.50
10.1%
4.0%
$1.56
$25.57
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Application
43. A share of Lash Inc.'s common stock just paid a dividend of $1.00. If the expected
long-run growth rate for this stock is 5.4%, and if investors' required rate of return
is 11.4%, what is the stock price?
a.
$16.28
b.
$16.70
c.
$17.13
d.
$17.57
e.
$18.01
ANS: D
Last dividend (D0)
Long-run growth rate
Required return
D1 = D0(1 + g) =
P0 = D1/(rs g)
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Constant growth valuation
TYPE: Multiple Choice: Problem
$1.00
5.4%
11.4%
$1.054
$17.57
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Application
44. Franklin Corporation is expected to pay a dividend of $1.25 per share at the end
of the year (D1 = $1.25). The stock sells for $32.50 per share, and its required
rate of return is 10.5%. The dividend is expected to grow at some constant rate,
g, forever. What is the equilibrium expected growth rate?
a.
6.01%
b.
6.17%
c.
6.33%
d.
6.49%
e.
6.65%
ANS: E
Expected dividend (D1)
Stock price
Required return
Dividend yield
Growth rate = rs D1/P0 =
PTS: 1
DIF: Difficulty: Easy
NAT: BUSPROG: Analytic
STA:
LOC: TBA
TOP: Constant growth rate
Application
MSC: TYPE: Multiple Choice: Problem
$1.25
$32.50
10.5%
3.85%
6.65%
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s:
45. $35.50 per share is the current price for Foster Farms' stock. The dividend is
projected to increase at a constant rate of 5.50% per year. The required rate of
return on the stock, rs, is 9.00%. What is the stock's expected price 3 years from
today?
a.
$37.86
b.
$38.83
c.
$39.83
d.
$40.85
e.
$41.69
ANS: E
Stock price
Growth rate
Years in the future
P3 = P0(1 + g)3 =
PTS:
NAT:
LOC:
MSC:
$35.50
5.50%
3
$41.69
1
DIF: Difficulty: Easy
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Constant growth: future price KEY: Bloom’s: Application
TYPE: Multiple Choice: Problem
46. Kelly Enterprises' stock currently sells for $35.25 per share. The dividend is
projected to increase at a constant rate of 4.75% per year. The required rate of
return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from
now?
a.
$40.17
b.
$41.20
c.
$42.26
d.
$43.34
e.
$44.46
ANS: E
Growth rate
Years in the future
Stock price
P5 = P0(1 + g)5 =
PTS:
NAT:
LOC:
MSC:
4.75%
5
$35.25
$44.46
1
DIF: Difficulty: Easy
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Constant growth: future price KEY: Bloom’s: Application
TYPE: Multiple Choice: Problem
47. If D1 = $1.25, g (which is constant) = 4.7%, and P 0 = $26.00, what is the stock's
expected dividend yield for the coming year?
a.
4.12%
b.
4.34%
c.
4.57%
d.
4.81%
e.
5.05%
ANS: D
D1
g
P0
Dividend yield = D1/P0 =
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Expected dividend yield
TYPE: Multiple Choice: Problem
$1.25
4.7%
$26.00
4.81%
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Application
48. If D0 = $2.25, g (which is constant) = 3.5%, and P 0 = $50, what is the stock's
expected dividend yield for the coming year?
a.
4.42%
b.
4.66%
c.
4.89%
d.
5.13%
e.
5.39%
ANS: B
D0
g
P0
D1 = D0(1 + g) =
Dividend yield = D1/P0 =
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Expected dividend yield
TYPE: Multiple Choice: Problem
$2.25
3.5%
$50.00
$2.329
4.66%
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Application
49. If D1 = $1.50, g (which is constant) = 6.5%, and P 0 = $56, what is the stock's
expected capital gains yield for the coming year?
a.
6.50%
b.
6.83%
c.
7.17%
d.
7.52%
e.
7.90%
ANS: A
D1
g
P0
Capital gains yield = g =
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Expected cap. gains yield
TYPE: Multiple Choice: Problem
$1.50
6.5%
$56.00
6.50%
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Application
50. If D1 = $1.25, g (which is constant) = 5.5%, and P 0 = $44, what is the stock's
expected total return for the coming year?
a.
7.54%
b.
7.73%
c.
7.93%
d.
8.13%
e.
8.34%
ANS: E
D1
g
P0
Total return = rs = D1/P0 + g
PTS: 1
DIF: Difficulty: Easy
NAT: BUSPROG: Analytic
STA:
LOC: TBA
TOP: Expected total return
Application
MSC: TYPE: Multiple Choice: Problem
$1.25
5.5%
$44.00
8.34%
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s:
51. If D0 = $1.75, g (which is constant) = 3.6%, and P 0 = $32.00, what is the stock's
expected total return for the coming year?
a.
8.37%
b.
8.59%
c.
8.81%
d.
9.03%
e.
9.27%
ANS: E
D0
g
P0
D1 = D0(1 + g) =
$1.75
3.6%
$32.00
$1.81
Total return = rs = D1/P0 + g
9.27%
PTS: 1
DIF: Difficulty: Easy
NAT: BUSPROG: Analytic
STA:
LOC: TBA
TOP: Expected total return
Application
MSC: TYPE: Multiple Choice: Problem
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s:
52. Barnette Inc.'s free cash flows are expected to be unstable during the next few
years while the company undergoes restructuring. However, FCF is expected to
be $50 million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth
rate is expected to be constant at 6% beyond that point. If the weighted average
cost of capital is 12%, what is the horizon value (in millions) at t = 5?
a.
$719
b.
$757
c.
$797
d.
$839
e.
$883
ANS: E
FCF5:
g:
WACC:
HV5
$50
6%
12%
= FCF6/(WACC g) = FCF5(1 + g)/
(WACC g)
= $50(1 + 0.06)/(0.12 0.06) =
$53/0.06 = $883
PTS: 1
DIF: Difficulty: Easy
OBJ: LO: 7-7
NAT: BUSPROG: Analytic
STA: DISC: Financial statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: Corporate valuation model, horizon value
KEY: Bloom’s: Application
MSC:
TYPE: Multiple Choice:
Problem
53. Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and
it expects FCF to grow at a constant rate of 5% thereafter. If the weighted
average cost of capital is 10% and the cost of equity is 15%, what is the horizon
value, in millions at t = 3?
a.
$840
b.
$882
c.
$926
d.
$972
e.
$1,021
ANS: A
FCF3:
g:
WACC:
$40
5%
10%
HV3
= FCF4/(WACC g) = FCF3(1 + g)/
(WACC g)
= $40(1 + 0.05)/(0.10 0.05) =
$42/0.05 = $840
PTS: 1
DIF: Difficulty: Easy
OBJ: LO: 7-7
NAT: BUSPROG: Analytic
STA: DISC: Financial statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: Corporate valuation model, horizon value
KEY: Bloom’s: Application
MSC:
TYPE: Multiple Choice:
Problem
54. Young & Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100
million, and FCF is expected to grow at a constant rate of 5% in the future. If the
weighted average cost of capital is 15%, what is the firm's value of operations, in
millions?
a.
$948
b.
$998
c.
$1,050
d.
$1,103
e.
$1,158
ANS: C
FCF0:
g:
WACC:
Value Ops
$100
5%
15%
= FCF1/(WACC g) = FCF0(1 + g)/
(WACC g)
= $100(1 + 0.05)/(0.15 0.05) =
$105/0.1 = $1,050
PTS: 1
DIF: Difficulty: Easy
OBJ: LO: 7-7
NAT: BUSPROG: Analytic
STA: DISC: Financial statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: Corporate valuation model, value of operations
KEY: Bloom’s: Application
MSC:
TYPE: Multiple Choice:
Problem
55. The projected cash flow for the next year for Minesuah Inc. is $100,000, and FCF
is expected to grow at a constant rate of 6%. If the company's weighted average
cost of capital is 11%, what is the value of its operations?
a.
$1,714,750
b.
$1,805,000
c.
$1,900,000
d.
$2,000,000
e.
$2,100,000
ANS: D
FCF1:
g:
$100,000
6%
WACC:
11%
Value Ops
= FCF1/(WACC g) = FCF0(1 + g)/
(WACC g)
= $100,000/(0.11 0.06) =
$100,000/0.05 = $2,000,000
PTS: 1
DIF: Difficulty: Easy
OBJ: LO: 7-7
NAT: BUSPROG: Analytic
STA: DISC: Financial statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: Corporate valuation model, value of operations
KEY: Bloom’s: Application
MSC:
TYPE: Multiple Choice:
Problem
56. Carby Hardware has an outstanding issue of perpetual preferred stock with an
annual dividend of $7.50 per share. If the required return on this preferred stock
is 6.5%, at what price should the preferred stock sell?
a.
$104.27
b.
$106.95
c.
$109.69
d.
$112.50
e.
$115.38
ANS: E
Preferred dividend
Required return
Preferred price = DP/rP =
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Easy
BUSPROG: Analytic
STA:
TBA
TOP: Preferred stock valuation
TYPE: Multiple Choice: Problem
$7.50
6.5%
$115.38
OBJ: LO: 7-9
DISC: Stocks and bonds
KEY: Bloom’s: Application
57. Dyer Furniture is expected to pay a dividend of D 1 = $1.25 per share at the end of
the year, and that dividend is expected to grow at a constant rate of 6.00% per
year in the future. The company's beta is 1.15, the market risk premium is 5.50%,
and the risk-free rate is 4.00%. What is Dyer's current stock price?
a.
$28.90
b.
$29.62
c.
$30.36
d.
$31.12
e.
$31.90
ANS: A
D1
b
rRF
RPM
g
rs = rRF + b(RPM) =
P0 = D1/(rs g)
$1.25
1.15
4.00%
5.50%
6.00%
10.33%
$28.90
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Constant g value: CAPM
TYPE: Multiple Choice: Problem
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
58. The Jameson Company just paid a dividend of $0.75 per share, and that dividend
is expected to grow at a constant rate of 5.50% per year in the future. The
company's beta is 1.15, the market risk premium is 5.00%, and the risk-free rate
is 4.00%. What is Jameson's current stock price, P0?
a.
$18.62
b.
$19.08
c.
$19.56
d.
$20.05
e.
$20.55
ANS: A
D0
b
rRF
RPM
g
D1 = D0(1 + g) =
rs = rRF + b(RPM) =
P0 = D1/(rs g)
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Constant g value: CAPM
TYPE: Multiple Choice: Problem
$0.75
1.15
4.0%
5.0%
5.5%
$0.7913
9.75%
$18.62
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
59. National Advertising just paid a dividend of D0 = $0.75 per share, and that
dividend is expected to grow at a constant rate of 6.50% per year in the future.
The company's beta is 1.25, the required return on the market is 10.50%, and the
risk-free rate is 4.50%. What is the company's current stock price?
a.
$14.52
b.
$14.89
c.
$15.26
d.
$15.64
e.
$16.03
ANS: A
D0
b
rRF
rM
g
D1 = D0(1 + g) =
rs = rRF + b(rM RRF) =
P0 = D1/(rs g)
$0.75
1.25
4.5%
10.5%
6.5%
$0.7988
12.0%
$14.52
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Constant g value: CAPM
TYPE: Multiple Choice: Problem
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
60. Kellner Motor Co.'s stock has a required rate of return of 11.50%, and it sells for
$25.00 per share. Kellner's dividend is expected to grow at a constant rate of
7.00%. What was the last dividend, D0?
a.
$0.95
b.
$1.05
c.
$1.16
d.
$1.27
e.
$1.40
ANS: B
Stock price
Required return
Growth rate
P0 = D1/(rs g), so D1 = P0(rs g) =
Last dividend = D0 = D1/(1 + g)
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Constant growth dividend
TYPE: Multiple Choice: Problem
$25.00
11.50%
7.00%
$1.1250
$1.05
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
61. Hirshfeld Corporation's stock has a required rate of return of 10.25%, and it sells
for $57.50 per share. The dividend is expected to grow at a constant rate of
6.00% per year. What is the expected year-end dividend, D 1?
a.
$2.20
b.
$2.44
c.
$2.69
d.
$2.96
e.
$3.25
ANS: B
Stock price
Required return
Growth rate
P0 = D1/(rs g), so D1 = P0(rs g)
Expected dividend = D1 = P0(rs g) =
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Constant growth dividend
TYPE: Multiple Choice: Problem
$57.50
10.25%
6.00%
$2.44
OBJ: LO: 7-5
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
62. Connolly Co.'s expected year-end dividend is D 1 = $1.60, its required return is rs =
11.00%, its dividend yield is 6.00%, and its growth rate is expected to be
constant in the future. What is Connolly's expected stock price in 7 years, i.e.,
what is ?
a.
b.
c.
d.
e.
$37.52
$39.40
$41.37
$43.44
$45.61
ANS: A
Next expected dividend = D1 =
Required return
Dividend yield = D1/P0 =
Find the growth rate: g = rs yield =
Find P0 = D1/(rs g) =
Years in the future
= P0(1 + g)7
PTS:
NAT:
LOC:
MSC:
$1.60
11.0%
6.0%
5.0%
$26.67
7
$37.52
1
DIF: Difficulty: Moderate
OBJ: LO: 7-5
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Constant growth: future price KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Problem
63. Alcott's preferred stock pays a dividend of $1.00 per quarter. If the price of the
stock is $45.00, what is its nominal (not effective) annual rate of return?
a.
8.03%
b.
8.24%
c.
8.45%
d.
8.67%
e.
8.89%
ANS: E
Pref. quarterly dividend
Annual dividend = Qtrly dividend 4
=
Preferred stock price
Nom. required return = Annual
dividend/Price =
PTS:
NAT:
LOC:
MSC:
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Preferred required return
TYPE: Multiple Choice: Problem
$1.00
$4.00
$45.00
8.89%
OBJ: LO: 7-9
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
64. Connor Publishing's preferred stock pays a dividend of $1.00 per quarter, and it
sells for $55.00 per share. What is its effective annual (not nominal) rate of
return?
a.
6.62%
b.
6.82%
c.
7.03%
d.
7.25%
e.
7.47%
ANS: E
Periods per year =
Pref. quarterly dividend
Preferred stock price
Eff % required return = (1+ (Qt
Div/P))N 1 =
PTS:
NAT:
LOC:
MSC:
4
$1.00
$55.00
7.47%
1
DIF: Difficulty: Moderate
BUSPROG: Analytic
STA:
TBA
TOP: Preferred required return
TYPE: Multiple Choice: Problem
OBJ: LO: 7-9
DISC: Stocks and bonds
KEY: Bloom’s: Analysis
65. Burke Tires just paid a dividend of D0 = $1.32. Analysts expect the company's
dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5%
in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What
is the best estimate of the stock's current market value?
a.
$41.59
b.
$42.65
c.
$43.75
d.
$44.87
e.
$45.99
ANS: D
rs = 9.0%
Year
Growth rates:
Dividend
Terminal value
= D3/(rs g3) =
Total CFs
PV of CFs
0
$1.32
1
30.0%
$1.716
49.550
2
10.0%
$1.888
$1.716
$1.574
$51.437
$43.294
3
5.0%
$1.982
Stock price = $44.87
PTS: 1
DIF: Difficulty: Moderate
OBJ: LO: 7-6
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Nonconstant growth valuation
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
66. Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will
be $10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is
expected to grow at a constant rate of 4% forever. If the weighted average cost of
capital is 14%, what is the firm's value of operations, in millions?
a.
$158
b.
$167
c.
$175
d.
$184
e.
$193
ANS: B
FCF1:
$10
FCF2:
g:
WACC:
$20
4%
14%
First, find the horizon, or terminal, value:
HV2 = FCF2(1 + g)/(WACC g) = $20(1.04)/(0.14 0.04) = $20.8/0.10 = $208.00
Then find the PV of the free cash flows and the horizon value:
Value of operations
= $10/(1.14)1 + ($20 + $208)/
(1.14)2
= $8.772 + $175.439 = $167
PTS:
NAT:
STA:
LOC:
KEY:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model, value of operations
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
67. The free cash flows (in millions) shown below are forecast by Parker & Sons. If the
weighted average cost of capital is 11% and FCF is expected to grow at a rate of
5% after Year 2, what is the Year 0 value of operations, in millions? Assume that
the ROIC is expected to remain constant in Year 2 and beyond (and do not make
any half-year adjustments).
Year:
Free cash flow:
a.
b.
c.
d.
e.
1
$50
2
$100
$1,456
$1,529
$1,606
$1,686
$1,770
ANS: A
FCF1:
FCF2:
g:
WACC:
$50
$100
5%
11%
First, find the horizon, or terminal, value:
HV2 = FCF2(1 + g)/(WACC g) = $100(1.05)/(0.11 0.05) = $1,750.00
Then find the PV of the free cash flows and the horizon value:
Value of operations = $50/(1.11) + ($100 + $1,750)/(1.11)2 = $1,456
PTS:
NAT:
STA:
LOC:
KEY:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model, value of operations
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
68. Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The
weighted average cost of capital is 13%, and the FCFs are expected to continue
growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain
constant in Year 3 and beyond, what is the Year 0 value of operations, in millions?
Year:
Free cash flow:
1
$15
a.
b.
c.
d.
e.
2
$10
3
$40
2
$10
3
$40
$315
$331
$348
$367
$386
ANS: E
Year:
FCF:
1
$15
g:
WACC:
5%
13%
First, find the horizon, or terminal, value:
HV4 = FCF3(1 + g)/(WACC g) = $40(1.05)/(0.13 0.05) = $525
Then find the PV of the free cash flows and the horizon value:
Value of operations = $15/(1.13) + $10/(1.13)2 + ($40 + $525)/(1.13)3 = $386
PTS:
NAT:
STA:
LOC:
KEY:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model, value of operations
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
69. Reynolds Construction's value of operations is $750 million based on the
corporate valuation model. Its balance sheet shows $50 million of short-term
investments that are unrelated to operations, $100 million of accounts payable,
$100 million of notes payable, $200 million of long-term debt, $40 million of
common stock (par plus paid-in-capital), and $160 million of retained earnings.
What is the best estimate for the firm's value of equity, in millions?
a.
$429
b.
$451
c.
$475
d.
$500
e.
$525
ANS: D
Value of operations:
Short-term investments:
Notes payable:
Long-term debt:
$750
$50
$100
$200
Assuming that the book value of debt is close to its market value, the total
market value of the company is:
Total market value
= Value of operations + Value of
non-operating assets
= $750 + $50 = $800.
Value of Equity
= Total MV Long- and Short-term
debt = $500.
The book value of equity figures are irrelevant for this problem. Also, the
accounts payable are not relevant because they were netted out when the FCF
was calculated.
PTS:
NAT:
STA:
LOC:
KEY:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model, value of equity
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
70. Based on the corporate valuation model, the value of Weidner Co.'s operations is
$1,200 million. The company's balance sheet shows $80 million in accounts
receivable, $60 million in inventory, and $100 million in short-term investments
that are unrelated to operations. The balance sheet also shows $90 million in
accounts payable, $120 million in notes payable, $300 million in long-term debt,
$50 million in preferred stock, $180 million in retained earnings, and $800 million
in total common equity. If Weidner has 30 million shares of stock outstanding,
what is the best estimate of the stock's price per share?
a.
$24.90
b.
$27.67
c.
$30.43
d.
$33.48
e.
$36.82
ANS: B
Value of operations:
Short-term investments:
Notes payable:
Long-term debt:
Preferred stock
Shares outstanding:
$1,200
$100
$120
$300
$50
30
Assuming that the book value of debt is close to its market value, the total
market value of the company is:
Total market value
= Value of operations + Value of
non-operating assets
= $1,200 + $100 = $1,300.
Value of Equity
Stock price
= Total MV Long- and Short-term
debt and preferred = $830
= Value of Equity/Shares
outstanding = $27.67
The book value of equity figures are irrelevant for this problem. Also, the working
capital account numbers are not relevant because they were netted out when the
FCF was calculated.
PTS:
NAT:
STA:
LOC:
MSC:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Problem
71. The value of Broadway-Brooks Inc.'s operations is $900 million, based on the
corporate valuation model. Its balance sheet shows $70 million in accounts
receivable, $50 million in inventory, $30 million in short-term investments that
are unrelated to operations, $20 million in accounts payable, $110 million in
notes payable, $90 million in long-term debt, $20 million in preferred stock, $140
million in retained earnings, and $280 million in total common equity. If the
company has 25 million shares of stock outstanding, what is the best estimate of
the stock's price per share?
a.
$23.00
b.
$25.56
c.
$28.40
d.
$31.24
e.
$34.36
ANS: C
Value of operations:
Short-term investments:
Notes payable:
Long-term debt:
Preferred stock
Shares outstanding:
$900
$30
$110
$90
$20
25
Assuming that the book value of debt is close to its market value, the total
market value of the company is:
Total market value
= Value of operations + Value of
non-operating assets
= $900 + $30 = $930.
Value of Equity
Stock price
= Total MV Long- and Short-term
debt and preferred = $710
= Value of Equity/Shares
outstanding = $28.40
The book value of equity figures are irrelevant for this problem. Also, the working
capital account numbers are not relevant because they were netted out when the
FCF was calculated.
PTS:
NAT:
STA:
LOC:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
72. Based on the corporate valuation model, Bizzaro Co.'s value of operations is $300
million. The balance sheet shows $20 million of short-term investments that are
unrelated to operations, $50 million of accounts payable, $90 million of notes
payable, $30 million of long-term debt, $40 million of preferred stock, and $100
million of common equity. Bizzaro has 10 million shares of stock outstanding.
What is the best estimate of the stock's price per share?
a.
$13.72
b.
$14.44
c.
$15.20
d.
$16.00
e.
$16.80
ANS: D
Value of operations:
Short-term investments:
Notes payable:
Long-term debt:
Preferred stock
Shares outstanding:
$300
$20
$90
$30
$40
10
Assuming that the book value of debt is close to its market value, the total
market value of the company is:
Total market value
= Value of operations + Value of
non-operating assets
= $300 + $20 = $320.
Value of Equity
Stock price
= Total MV Long- and Short-term
debt and preferred = $160
= Value of Equity/Shares
outstanding = $16.00
The book value of equity figures are irrelevant for this problem. Also, the working
capital account numbers are not relevant because they were netted out when the
FCF was calculated.
PTS:
NAT:
STA:
LOC:
MSC:
1
DIF: Difficulty: Moderate
OBJ: LO: 7-7
BUSPROG: Analytic
DISC: Financial statements, analysis, forecasting, and cash flows
TBA
TOP: Corporate valuation model
KEY: Bloom’s: Analysis
TYPE: Multiple Choice: Problem
73. McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for
the next 4 years, after the growth rate in earnings and dividends will fall to zero,
i.e., g = 0. The company's last dividend, D 0, was $1.25, its beta is 1.20, the
market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current
price of the common stock?
a.
$26.77
b.
$27.89
c.
$29.05
d.
e.
$30.21
$31.42
ANS: C
Last dividend (D0)
Short-run growth rate
Long-run growth rate
Beta
Market risk premium
Risk-free rate
Required return = rs = rRF + b(RPM) =
Year
Dividend
0
$1.2500
Terminal
value =
D5/(rs g5)
=
Total CFs
PV of the
CFs
1
25%
$1.5625
2
25%
$1.9531
$1.25
25%
0%
1.20
5.50%
3.00%
9.60%
3
25%
$2.4414
4
25%
$3.051
8
$34.840
9
$24.146
1
5
0%
$3.0518
31.789
1
$1.5625
$1.9531
$2.4414
$1.4256
$1.6260
$1.8544
Price = Sum of PVs = $29.05
PTS: 1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Nonconstant growth valuation
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
74. Orwell Building Supplies' last dividend was $1.75. Its dividend growth rate is
expected to be constant at 25% for 2 years, after which dividends are expected
to grow at a rate of 6% forever. Its required return (r s) is 12%. What is the best
estimate of the current stock price?
a.
$41.58
b.
$42.64
c.
$43.71
d.
$44.80
e.
$45.92
ANS: B
Last dividend (D0)
Short-run growth rate
Long-run growth rate
Required return
Year
$1.75
25%
6%
12%
0
1
25.00%
2
25.00%
3
6.00%
Dividend
Terminal value
= D3/(rs g3) =
Total CFs
PV of CFs
$1.7500
$2.1875
48.3073
$2.1875
$1.9531
$2.7344
$2.8984
$51.0417
$40.6901
Price = Sum of PVs = $42.64
PTS: 1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Nonconstant growth valuation
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
75. The last dividend paid by Wilden Corporation was $1.55. The dividend growth rate
is expected to be constant at 1.5% for 2 years, after which dividends are
expected to grow at a rate of 8.0% forever. The firm's required return (r s) is
12.0%. What is the best estimate of the current stock price?
a.
$37.05
b.
$38.16
c.
$39.30
d.
$40.48
e.
$41.70
ANS: A
Last dividend (D0)
Short-run growth rate
Long-run growth rate
Required return
Year
Dividend
Terminal value
= D3/(rs g3) =
Total CFs
PV of CFs
$1.55
1.50%
8.00%
12.00%
0
$1.5500
1
1.50%
$1.5733
43.1149
$1.5733
$1.4047
2
1.50%
$1.5968
3
8.00%
$1.7246
$44.7118
$35.6439
Price = Sum of PVs = $37.05
PTS: 1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Nonconstant growth valuation
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
76. The last dividend paid by Coppard Inc. was $1.25. The dividend growth rate is
expected to be constant at 15% for 3 years, after which dividends are expected
to grow at a rate of 6% forever. If the firm's required return (r s) is 11%, what is its
current stock price?
a.
$30.57
b.
c.
d.
e.
$31.52
$32.49
$33.50
$34.50
ANS: D
Required return
Short-run growth rate
Long-run growth rate
Last dividend (D0)
Year
Dividend
Terminal
value = P3
= D4/(rs g4)
=
Total CFs
PV of CFs
11.0%
15.0%
6.0%
$1.25
0
$1.2500
1
$1.4375
2
$1.6531
40.3032
$1.4375
$1.2950
$1.6531
$1.3417
3
$1.9011
4
$2.0152
$42.2043
$30.8594
Price = Sum of PVs = $33.50
PTS: 1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Nonconstant growth valuation
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
77. Sawchuck Consulting has been profitable for the last 5 years, but it has never
paid a dividend. Management has indicated that it plans to pay a $0.25 dividend
3 years from today, then to increase it at a relatively rapid rate for 2 years, and
then to increase it at a constant rate of 8.00% thereafter. Management's forecast
of the future dividend stream, along with the forecasted growth rates, is shown
below. Assuming a required return of 11.00%, what is your estimate of the stock's
current value?
Year
Growth
rate
Dividen
ds
0
NA
1
NA
2
NA
3
NA
4
50.00%
5
25.00%
6
8.00%
$0.000
$0.000
$0.000
$0.250
$0.375
$0.469
$0.506
4
5
6
a.
b.
c.
d.
e.
ANS: D
Required return = 11%
Year
0
1
$9.94
$10.19
$10.45
$10.72
$10.99
2
3
Dividen
d
Terminal
value =
P5 = D6/
(rs g6)
=
Total
CFs
PV of
CFs
$0.000
$0.000
$0.000
$0.250
50.00%
$0.375
25.00%
$0.46
9
$17.34
4
$10.29
3
8.00%
$0.506
16.87
5
$0.000
$0.000
$0.250
$0.375
$0.000
$0.000
$0.183
$0.247
Price = $10.72
PTS: 1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
NAT: BUSPROG: Analytic
STA:
DISC: Stocks and bonds
LOC: TBA
TOP: Nonconstant growth valuation
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
78. The free cash flows (in millions) shown below are forecast by Simmons Inc. If the
weighted average cost of capital is 13% and the free cash flows are expected to
continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is
the Year 0 value of operations, in millions?
Year:
Free cash flow:
1
$20
a.
b.
c.
d.
e.
ANS: B
Year:
Free cash flow:
2
$42
3
$45
2
$42
3
$45
$586
$617
$648
$680
$714
1
$20
WACC: 13%
First, find the growth rate: g = $45/$42 1.0 = 7.14%
Second, find the horizon, or terminal, value, at Year 2:
HV2 = FCF3/(WACC g) = $45/(0.13 0.0714) = $768
Now find the PV of the FCFs and the horizon value:
Value of operations = $20/(1.13) + ($42 + $768)/(1.13)2 = $617
PTS: 1
DIF: Difficulty: Challenging
OBJ: LO: 7-7
NAT: BUSPROG: Analytic
STA: DISC: Financial statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: Corporate valuation model, value of operations
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
79. The required return for Williamson Heating's stock is 12%, and the stock sells for
$40 per share. The firm just paid a dividend of $1.00, and the dividend is
expected to grow by 30% per year for the next 4 years, so D 4 = $1.00(1.30)4 =
$2.8561. After t = 4, the dividend is expected to grow at a constant rate of X%
per year forever. What is the stock's expected constant growth rate after t = 4,
i.e., what is X?
a.
5.17%
b.
5.44%
c.
5.72%
d.
6.02%
e.
6.34%
ANS: E
Stock price
Paid dividend (D0)
Short-run growth rate
Required return
Forecasted LR growth
rate, X
Year
0
Dividend
$1.0000
$40.00
$1.00
30.0%
12.0%
6.34% Arbitrarily set at 5%
initially.
1
30.0%
$1.3000
2
30.0%
$1.6900
3
30.0%
$2.1970
4
30.0%
$2.856
1
$56.533
8
$35.928
2
Terminal
value =
P4 = D5/(rs
g5):
Total CFs
$1.3000
$1.6900
$2.1970
PV of CFs
$1.1607
$1.3473
$1.5638
5
6.34%
$3.0372
53.677
7
Stock price = $40.00. Must equal $40. Change the forecasted growth rate till
reach $40.
We must solve for the long-run growth rate. We can forecast the dividends in
Years 1-4, so they are inserted in the time line. We need a growth rate to find D 5
and the TV. We begin with a guess of say 5.0%, which we insert in the forecast
cell. We then find the PV of the forecasted CFs and sum them. If the sum equals
the given price, then our growth rate would be correct. If not, we need to
substitute in different g's until we find the one that works. We used Excel's Goal
Seek function to simplify the process, but one could use trial and error.
PTS:
NAT:
LOC:
KEY:
1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Nonconstant growth rate–nonalgorithmic
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
80. Julia Saunders is your boss and the treasurer of Foster Carter Enterprises (FCE).
She asked you to help her estimate the intrinsic value of the company's stock.
FCE just paid a dividend of $1.00, and the stock now sells for $15.00 per share.
Julia asked a number of security analysts what they believe FCE's future
dividends will be, based on their analysis of the company. The consensus is that
the dividend will be increased by 10% during Years 1 to 3, and it will be increased
at a rate of 5% per year in Year 4 and thereafter. Julia asked you to use that
information to estimate the required rate of return on the stock, r s, and she
provided you with the following template for use in the analysis:
Julia told you that the growth rates in the template were just put in as a trial, and
that you must replace them with the analysts' forecasted rates to get the correct
forecasted dividends and then the estimated TV. She also notes that the
estimated value for rs, at the top of the template, is also just a guess, and you
must replace it with a value that will cause the Calculated Price shown at the
bottom to equal the Actual Market Price. She suggests that, after you have put in
the correct dividends, you can manually calculate the price, using a series of
guesses as to the Estimated rs. The value of rs that causes the calculated price to
equal the actual price is the correct one. She notes, though, that this trial-anderror process would be quite tedious, and that the correct r s could be found much
faster with a simple Excel model, especially if you use Goal Seek. What is the
value of rs?
a.
11.84%
b.
12.21%
c.
12.58%
d.
12.97%
e.
13.36%
ANS: D
Finding the discount rate when we know the dividends and the actual stock price
is complicated if the growth rate is not constant, and an iterative solution is
required.
Estimated
rs =
Actual
Market
Price, P0:
Year
Dividend
growth
rate
Dividends
(D0 has
been
paid)
TV3 = P3
= D4/(rs 
12.97%
$15.00
0
$1.00
Rapid
Growth
1
10%
Normal
Growth
2
10%
$1.100
$1.210
$17.527
3
10%
$1.331
4
5%
$1.398
5
5%
g4). Use
Estimated
rs.
Total CFs
PVs of
CFs
discounte
d at
Estimated
rs
$0.974
$1.100
$0.948
$1.210
$13.078
$18.858
Calculated Price = P0 = Sum of PVs = $15.00
PTS:
NAT:
LOC:
KEY:
1
DIF: Difficulty: Challenging
OBJ: LO: 7-6
BUSPROG: Analytic
STA:
DISC: Stocks and bonds
TBA
TOP: Nonconstant value: Excel–nonalgorithmic
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem