Chapter 7 - Test Bank

Chapter 07 - Valuing Stocks

Chapter 07 Valuing Stocks True / False Questions

1. The term "irrational exuberance" was coined b !ormer ed Chairman #lan $reenspan to describe the dot-com boom. True alse

%. The di&idend discount model indicates that the &alue o! a stock is the present &alue o! the di&idends it will pa o&er the in&estor's hori(on plus p lus the present &alue o! the expected stock price at the end o! that hori(on. True alse

). *! in&estors belie&e a compan will ha&e the opportunit to make &er pro!itable in&estments in the !uture+ the will pa more !or the compan's stock toda. True alse

,. The di&idend discount model should not be used to &alue stocks in which the di&idend does not grow. True alse

. $oogle's stock price tripling a!ter the */ suggests that &aluing growth stocks is an exact science. True alse

. Sustainable growth rates can be estimated b multipling a !irm's /2 b its di&idend paout ratio. True alse

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7. #ccording to the di&idend discount model+ a stock's price toda depends on the in&estor's hori(on !or holding the stock. True alse

3. The di&idend ield o! a stock is much like the current ield o! a bond. 4oth ignore prospecti&e capital gains or losses. True alse

5. The di&idend discount model states that toda's stock price e6uals the present &alue o! all expected !uture di&idends. True alse

10. #n excess o! market &alue o&er the book &alue o! e6uit can be attributed to going concern &alue. True alse

11. Securities with the same expected risk should o!!er the same expected rate o! return. True alse

1%. The li6uidation &alue o! o ! a !irm is e6ual to the book &alue o! the !irm. True alse

1). arket price is not the same as book &alue or li6uidation &alue. True alse

1,. arket &alue+ unlike book &alue and li6uidation &alue+ treats the !irm as a going concern. True alse

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7. #ccording to the di&idend discount model+ a stock's price toda depends on the in&estor's hori(on !or holding the stock. True alse

3. The di&idend ield o! a stock is much like the current ield o! a bond. 4oth ignore prospecti&e capital gains or losses. True alse

5. The di&idend discount model states that toda's stock price e6uals the present &alue o! all expected !uture di&idends. True alse

10. #n excess o! market &alue o&er the book &alue o! e6uit can be attributed to going concern &alue. True alse

11. Securities with the same expected risk should o!!er the same expected rate o! return. True alse

1%. The li6uidation &alue o! o ! a !irm is e6ual to the book &alue o! the !irm. True alse

1). arket price is not the same as book &alue or li6uidation &alue. True alse

1,. arket &alue+ unlike book &alue and li6uidation &alue+ treats the !irm as a going concern. True alse

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1. #t each point in time all securities o! the same risk are priced to o!!er the same expected rate o! return. True alse

1. *! the stock prices !ollow a random walk+ successi&e stock prices are not related. True alse

17. *! the stock prices !ollow a random walk+ successi&e stock price changes are not related. True alse

13. *! the market is e!!icient+ stock prices should be expected exp ected to react onl to new in!ormation that is released. True alse

15. The intent o! technical analsis a nalsis is to disco&er patterns in past stock prices. True alse

%0. Technical analsts ha&e no e!!ect on the e!!icienc o! the stock market. True alse

%1. Technical analsts would be more likel than other in&estors to index their port!olios. True alse

%%. arket e!!icienc implies that securit prices impound new in!ormation 6uickl. 6uickl. True alse

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%). *! the stock prices !ollow a random walk+ successi&e stock prices !luctuate abo&e and below a normal long-run price. True alse

%,. *! securit prices !ollow a random walk+ then on an particular da the odds are that an increase or decrease in price is e6uall likel. True alse

%. undamental analsts attempt to get rich b identi!ing patterns in stock prices. True alse

%. Strong-!orm market e!!icienc implies that one could earn abo& e-a&erage returns b examining the histor o! a !irm's stock price. True alse

Multiple Choice Questions

%7. The rise o! the dot-coms in the late 1550s is probabl due to8 #. in&estors reducing their expectations !rom common stocks. 4. in&estors being reluctant to incur losses and being o&ercon!ident. C. a sharp impro&ement in the prospects !or di&idend growth. 9. the e!!icienc o! the markets.

%3. :hat di&idend ield would be reported in the !inancial press !or a stock that currentl pas a ;1 di&idend per 6uarter and the most recent stock price was ;,0< #. %.= 4. ,.0= C. 10.0= 9. 1.0=

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%5. :hich o! the !ollowing describes a seasoned o!!ering< #. #n */ o! common stock !or a well-known !irm. 4. #n */ that is o!!ered during the best buing season. C. #n additional e6uit issue !rom a publicl traded !irm. 9. #n shares traded in the secondar market are seasoned o!!erings.

)0. :hich o! the !ollowing best characteri(es the di!!erence between growth stocks and income stocks< #. $rowth stocks do not pa di&idends. 4. *ncome stocks o!!er higher rates o! return. C. *ncome stocks are seasoned issues. 9. $rowth stocks ha&e greater V$/.

)1. *! The Wall Street Journal lists a stock's di&idend as ;1+ then it is most likel the case that the stock8 #. pas ;1 6uarterl+ or an estimated ;, annuall. 4. pas ;0.% 6uarterl+ or an estimated ;1 annuall. C. paid ;1 during the past 6uarter+ with no !uture di&idends !orecast. 9. paid ;1 during the past ear+ with no !uture di&idends !orecast.

)%. >ow much should ou pa !or a share o! stock that o!!ers a constant-growth rate o! 10=+ re6uires a 1= rate o! return+ and is expected to sell !or ;0 one ear !rom now< #. ;,%.00 4. ;,.00 C. ;,., 9. ;,7.00

)). >ow is it possible to ignore cash di&idends that occur !ar into the !uture when using a di&idend discount model< Those di&idends8 #. will be paid to a di!!erent in&estor. 4. will not be paid b the !irm. C. ha&e an insigni!icant present &alue. 9. ignore the tax conse6uences o! !uture di&idends.

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),. *! the di&idend ield !or ear 1 is expected to be = based on the current price o! ;%+ what will the ear , di&idend be i! di&idends grow at a constant =< #. ;1.)) 4. ;1.,5 C. ;1.3 9. ;1.7

). The &alue o! common stock will likel decrease i!8 #. the in&estment hori(on decreases. 4. the growth rate o! di&idends increases. C. the discount rate increases. 9. di&idends are discounted back to the present.

). :hen &aluing stock with the di&idend discount model+ the present &alue o! !uture di&idends will8 #. change depending on the time hori(on selected. 4. remain constant regardless o! the time hori(on selected. C. remain constant regardless o! growth rate. 9. alwas e6ual the present &alue o! the terminal price.

)7. Common stock can be &alued using the perpetuit &aluation !ormula i! the8 #. discount rate is expected to remain constant. 4. di&idends are not expected to grow. C. growth rate in di&idends is not constant. 9. in&estor does not intend to sell the stock.

)3. :hat should be the price !or a common stock paing ;).0 annuall in di&idends i! the growth rate is (ero and the discount rate is 3=< #. ;%%.3 4. ;%3.00 C. ;,%.00 9. ;,).7

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)5. *! next ear's di&idend is !orecast to be ;.00+ the constant-growth rate is ,=+ and the discount rate is 1=+ then the current stock price should be8 #. ;)1.% 4. ;,0.00 C. ;,1.7 9. ;,).))

,0. :hat price would ou expect to pa !or a stock with 1)= re6uired rate o! return+ ,= rate o! di&idend growth+ and an annual di&idend o! ;%.0 which will be paid tomorrow< #. ;%7.73 4. ;)0.%3 C. ;)1.10 9. ;)1.)5

,1. :hat constant-growth rate in di&idends is expected !or a stock &alued at ;)%.00 i! next ear's di&idend is !orecast at ;%.00 and the appropriate discount rate is 1)=< #. .00= 4. .%= C. .7= 9. 1.)3=

,%. #4C common stock is expected to ha&e extraordinar growth o! %0= per ear !or % ears+ at which time the growth rate will settle into a constant =. *! the discount rate is 1= and the most recent di&idend was ;%.0+ what should be the approximate current share price< #. ;)1.1 4. ;)).%) C. ;)7.,% 9. ;,7.77

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,). # paout ratio o! )= !or a compan indicates that8 #. )= o! di&idends are plowed back !or growth. 4. = o! di&idends are plowed back !or growth. C. = o! earnings are paid out as di&idends. 9. )= o! earnings are paid out as di&idends.

,,. :hat would be the approximate expected price o! a stock when di&idends are expected to grow at a %= rate !or ) ears+ then grow at a constant rate o! =+ i! the stock's re6uired return is 1)= and next ear's di&idend will be ;,.00< #. ;1.0 4. ;%.03 C. ;3.% 9. ;75.,,

,. :hat is the plowback ratio !or a !irm that has earnings per share o! ;1%.00 and pas out ;,.00 per share as di&idends< #. %.00= 4. )).))= C. .7= 9. 7.00=

,. :hat happens to a !irm that rein&ests its earnings at a rate e6ual to the !irm's re6uired return< #. *ts stock price will remain constant. 4. *ts stock price will increase b the sustainable growth rate. C. *ts stock price will decline unless di&idend paout ratio is (ero. 9. *ts stock price will decline unless plowback rate exceeds re6uired return.

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,7. :hat can be expected to happen when stocks ha&ing the same expected risk do not ha&e ha&e the same expected return< #. #t least one o! the stocks becomes temporaril mispriced. 4. This is a common occurrence indicating that one stock has more V$/. C. This cannot happen happen i! the shares are traded in an auction market. 9. The expected risk le&els will change until the expected returns are e6ual.

,3. 9i&idends that are expected to be paid !ar into the !uture ha&e8 #. great impact on current stock price due to their expected si(e. 4. e6ual impact on current stock price as near-term di&idends. C. lesser impact on current stock price due to discounting. 9. no impact on current stock price because the are uncertain.

,5. :hich o! the !ollowing is more likel to be responsible !or a !irm ha&ing low V$/< #. /2 exceeds re6uired return. 4. lowback is &er high. C. aout is &er high. 9. 4ook &alue o! e6uit e6 uit is low. low.

0. :hat is the most likel &alue o! the V$/ !or a stock with current price o! o ! ;0+ expected earnings o! ; per share+ and a re6uired return o! %0=< #. ;10 4. ;%0 C. ;% 9. ;)0

1. :hat is the expected constant-growth rate o! di&idends !or a stock with current price o! ;100+ expected di&idend pament o! ;10 per share+ and a re6uired return o! 1=< #. .00= 4. .%= C. 3.00= 9. 10.00=

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%. :hich o! the !ollowing is least assured assured !or !irms that plowback a portion o! earnings into the !irm< #. $rowth in earnings per share 4. $rowth in di&idends per share C. $rowth in book &alue o! e6uit 9. $rowth in stock price

). :hat should be the price o! a stock that o!!ers a ;, annual di&idend with no prospects o! growth+ and has a re6uired return o! 1%.=< #. ;3.0 4. ;%.00 C. ;)%.00 9. ;0.00

,. :hat should be the stock &alue one ear !rom toda !or a stock that currentl sells !or ;)+ has a re6uired return o! 1=+ an expected di&idend o! ;%.30+ and a constant di&idend growth rate o! 7=< #. ;)7., 4. ;)7.30 C. ;,0.% 9. ;,).0

. :hat should be the current price o! a share o! stock i! a ; di&idend was ?ust paid+ the stock has a re6uired return o! %0=+ and a constant di&idend growth rate o! =< #. ;15.%) 4. ;%.00 C. ;).71 9. ;)7.3

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. :hat should be the current price o! a stock i! the expected di&idend is ;+ the stock has a re6uired return o! %0=+ and a constant di&idend growth rate o! =< #. ;15.%) 4. ;%.00 C. ;).71 9. ;)7.3

7. ein&esting earnings into a !irm will not increase the stock price unless8 #. the new paradigm o! stock pricing is maintained. 4. true depreciation is less than reported depreciation. C. the !irm's di&idends are growing also. 9. the /2 o! new in&estments exceeds the !irm's re6uired return.

3. >ow much o! a stock's ;)0 price is re!lected in V$/ i! it expects to earn ;, per share+ has an expected di&idend o! ;%.0+ and a re6uired return o! %0=< #. ;0 4. ;.00 C. ;3.00 9. ;10.00

5. *n a &aluation o! a nonconstant di&idend growth stock+ the terminal &alue represents the8 #. point at which the present &alue o! !uture di&idends e6uals (ero. 4. maturit date o! the stock. C. present &alue o! !uture di&idends !rom that point on. 9. highest &alue that the stock will attain.

0. :hat stock price reaction would ou expect !rom a !irm that unexpectedl raises its di&idend permanentl and b a substantial amount< #. rice should rise+ gi&en di&idend discount models. 4. rice should decline+ gi&en discounted cash !low analsis. C. rice will remain constant+ due to market e!!icienc. 9. rice will remain constant+ due to random-walk beha&ior.

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1. *n the calculation o! rates o! return on common stock+ di&idends are @@@@@@@ and capital gains are @@@@@. #. guaranteedA not guaranteed 4. guaranteedA guaranteed C. not guaranteedA not guaranteed 9. not guaranteedA guaranteed

%. :hich o! the !ollowing &alues treats the !irm as a going concern< #. arket &alue 4. 4ook &alue C. Bi6uidation &alue 9. one o! these

). The book &alue o! a !irm's e6uit is determined b8 #. multipling share price b shares outstanding. 4. multipling share price at issue b shares outstanding. C. the di!!erence between book &alues o! assets and liabilities. 9. the di!!erence between market &alues o! assets and liabilities.

,. *! the li6uidation &alue o! a !irm is negati&e+ then8 #. the !irm's debt exceeds the market &alue o! assets. 4. the !irm's debt exceeds the book &alue o! e6uit. C. the book &alue o! assets exceeds the !irm's debt. 9. the market &alue o! assets exceeds the !irm's debt.

. # !irm's li6uidation &alue is the amount8 #. necessar to repurchase all shares o! common stock. 4. reali(ed !rom selling all assets and paing o!! its creditors. C. a purchaser would pa !or the !irm in bankruptc. 9. e6ual to the book &alue o! e6uit.

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. :hich o! the !ollowing is least likel to account !or an excess o! market &alue o&er book &alue o! e6uit< #. *naccurate depreciation methods 4. >igh rate o! return on assets C. The presence o! growth opportunities 9. Valuable o!!-balance sheet assets

7. irms with &aluable intangible assets are more likel to show aDnE8 #. excess o! book &alue o&er market &alue o! e6uit. 4. high going-concern &alue. C. low li6uidation &alue. 9. low F2 ratio.

3. :hich o! the !ollowing is inconsistent with a !irm that sells !or &er near book &alue< #. Bow current earning power 4. o intangible assets C. >igh !uture earning power 9. Bow+ unstable di&idend pament

5. The main purpose o! a market-&alue balance sheet is to8 #. show an in!lated &alue o! the !irm. 4. a&oid the recording o! certain liabilities. C. &alue assets and liabilities without $## restrictions. 9. impro&e the credit rating o! the !irm.

70. # stock paing ; in annual di&idends sells now !or ;30 and has an expected return o! 1,=. :hat might in&estors expect to pa !or the stock 1 ear !rom now< #. ;3%.%0 4. ;3.%0 C. ;37.%0 9. ;51.%0

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71. :hich o! the !ollowing statements is correct about a stock currentl selling !or ;0 per share that has a 1= expected return and a 10= expected capital appreciation< #. *ts expected di&idend exceeds the actual di&idend. 4. *ts expected return will exceed the actual return. C. *t is expected to pa ;) in annual di&idends. 9. *t is expected to pa ;3 in annual di&idends.

7%. The expected return on a common stock is composed o!8 #. di&idend ield. 4. capital appreciation. C. both di&idend ield and capital appreciation. 9. capital appreciation minus the di&idend ield.

7). irms ha&ing a higher expected return ha&e a higher8 #. le&el o! expected risk. 4. di&idend ield. C. market &alue o! e6uit. 9. degree o! certaint concerning their returns.

7,. :hat is the expected di&idend to be paid in ) ears i! esterda's di&idend was ;.00+ di&idends are expected to grow at a constant = annual rate+ and the !irm has a 10= expected return< #. ;.7 4. ;7.1 C. ;7.30 9. ;5.)7

7. 9i&iding a stock's earnings per share b the expected rate o! return will &alue the share correctl i! no new shares are issued and the di&idend ield8 #. exceeds the re6uired return. 4. e6uals the re6uired return. C. is (ero. 9. is constant.

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7. :hat rate o! return is expected !rom a stock that sells !or ;)0 per share+ pas ;1.0 annuall in di&idends+ and is expected to sell !or ;)) per share in one ear< #. .00= 4. 10.00= C. 1,.05= 9. 1.00=

77. # compan with a return on e6uit o! 1= and a plowback ratio o! 0= would expect a constant-growth rate o!8 #. ,=. 4. 5=. C. %1=. 9. %=.

73. :hat is the return on e6uit !or a !irm that has a constant di&idend growth rate o! 7= and a di&idend paout ratio o! 0=< #. %.30= 4. ,.%0= C. 11.7= 9. 17.0=

75. # positi&e &alue !or V$/ suggests that the !irm has8 #. a positi&e return on e6uit. 4. a positi&e plowback ratio. C. in&estment opportunities with superior returns. 9. a high rate o! constant growth.

30. :hich o! the !ollowing situations accuratel describes a growth stock+ assuming that each !irm has a re6uired return o! 1%=< #. # !irm with V$/ G ;0. 4. # !irm with in&estment opportunities ielding 10=. C. # !irm with in&estment opportunities ielding 1=. 9. #ll o! these !irms represent growth stocks.

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31. /ther things e6ual+ a !irm's sustainable growth rate could increase as a result o!8 #. increasing the plowback ratio. 4. increasing the paout ratio. C. decreasing the return on e6uit. 9. increasing total assets.

3%. :hich o! the !ollowing is least likel to contribute to going concern &alue< #. >igh li6uidation &alue 4. 2xtra earning power C. uture in&estment opportunities 9. *ntangible assets

3). The terminal &alue o! a share o! stock8 #. is similar to the maturit &alue o! a bond. 4. re!ers to the share &alue at the end o! the in&estor's holding period. C. is the &alue recei&ed b in&estors upon li6uidation o! the !irm. 9. is the price !or shares traded through a dealers' market.

3,. :hich o! the !ollowing is true !or a !irm ha&ing a stock price o! ;,%+ an expected di&idend o! ;)+ and a sustainable growth rate o! 3=< #. *t has a re6uired return o! 1.1,=. 4. *t has a di&idend paout ratio o! )7.=. C. *t has an /2 o! 7.1,=. 9. *t has a plowback rate o! 7.1,=.

3. :hat is the &alue o! the expected di&idend per share !or a stock that has a re6uired return o! 1=+ a price o! ;,+ and a constant-growth rate o! 1%=< #. ;1.30 4. ;).0 C. ;,.0 9. ;7.%0

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3. :hat is the re6uired return !or a stock that has a = constant-growth rate+ a price o! ;%+ an expected di&idend o! ;%+ and a F2 ratio o! 10< #. = 4. 10= C. 1,= 9. %%=

37. :hat is the minimum amount that shareholders should expect to recei&e in the e&ent o! a complete corporate li6uidation< #. arket &alue o! e6uit. 4. 4ook &alue o! e6uit. C. Hero. 9. Shareholders ma be re6uired to pay to be li6uidated.

33. The re6uired return on an e6uit securit is comprised o! a8 #. di&idend ield and /2. 4. current ield and a terminal &alue. C. sustainable growth rate and a plowback ield. 9. di&idend ield and a capital gains ield.

35. :hat proportion o! earnings is being plowed back into the !irm i! the sustainable growth rate is 3= and the !irm's /2 is %0=< #. 3= 4. 1%= C. %0= 9. ,0=

50. :hat is the expected constant-growth rate o! di&idends !or a stock currentl priced at ;0+ that ?ust paid a di&idend o! ;,+ and has a re6uired return o! 13=< #. ).,1= 4. .0= C. 5.%= 9. 1%.=

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51. *! the li6uidation &alue o! a corporation exceeds the market &alue o! the e6uit+ then the8 #. !irm has no &alue as a going concern. 4. !irm's stock will sell !or book &alue. C. !irm is not taking ad&antage o! a&ailable growth opportunities. 9. di&idend paout ratio has been too high.

5%. #n in&estor is !aced with the decision o! whether to in&est in a stock with an expected return o! 1,= or a stock in the same industr with an expected %0= return. :hich o! the !ollowing seems most likel< #. The %0= stock is a better in&estment. 4. The 1,= stock is o&erpriced. C. 4oth stocks will ha&e approximatel the same return. 9. 4oth stocks are priced correctl gi&en their percei&ed risk.

5). *! a stock's F2 ratio is 1). at a time when earnings are ;) per ear+ what is the stock's current price< #. ;,.0 4. ;13.00 C. ;%%.%% 9. ;,0.0

5,. :hat is the current price o! a share o! stock !or a !irm with ; million in balance-sheet e6uit+ 00+000 shares o! stock outstanding+ and a priceFbook &alue ratio o! ,< #. ;%.0 4. ;10.00 C. ;%0.00 9. ;,0.00

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5. #ssuming all o! the !ollowing !irms ha&e a re6uired return o! 1,=+ which would ou expect to ha&e a positi&e present &alue o! growth opportunities< #. # !irm with a F2 ratio o! 5. 4. # !irm with a F2 ratio o! . C. # !irm with an 2F ratio o! %0=. 9. one o! these !irms are expected to ha&e positi&e V$/.

5. *n&estors are willing to purchase stocks ha&ing high F2 ratios because8 #. the expect these shares to sell !or a lower price. 4. the expect these shares to o!!er higher di&idend paments. C. these shares are accompanied b guaranteed earnings. 9. the expect these shares to ha&e greater growth opportunities.

57. 4estirm has a 0-ear histor o! solid growth and e&er-increasing pro!its. *t is widel regarded as the leading !irm o! its industr. >ence+ 4estirm's stock8 #. should be a good bu. 4. cannot be a good bu. C. should be a sa!e bu. 9. cannot be a sa!e bu.

53. Book$ood+ *nc. has ?ust announced the bad news that its earnings ha&e dropped b )0=. *n !act+ its in&estors had anticipated e&en worse results Da decrease o! ,0=E. #s a result+ Book$ood's stock price8 #. increases. 4. remains the same. C. decreases. 9. !ollows a random walk as usual.

55. :hat is the di!!erence between a !undamental analst and a technical analst< #. /nl a !undamental analst belie&es markets are ine!!icient. 4. # technical analst !ocuses on !inancial statement analsis. C. /nl a technical analst helps keep the market e!!icient. 9. # !undamental analst anal(es such in!ormation as earnings and asset &alues.

7-15


100. :hich o! the !ollowing obser&ations pro&ides e&idence against strong-!orm market e!!icienc< #. Some mutual !unds outper!ormed the market in 1557. 4. anagers trading in their own stock obtain superior returns. C. Iou cannot make superior pro!its b trading stocks a!ter earnings reports are issued. 9. Stock prices !ollow a random walk.

101. #ccording to the semistrong !orm o! market e!!icienc+ when new in!ormation becomes a&ailable in the market8 #. stock prices will remain unchanged because the alread re!lect this in!ormation. 4. stock prices will accuratel and rapidl ad?ust to re!lect this new in!ormation. C. stock prices will ad?ust to accuratel re!lect this new in!ormation o&er the course o! the next !ew das. 9. stock prices will most likel increase because all new in!ormation has a positi&e e!!ect on stock prices.

10%. :ith respect to the notion that stock prices !ollow a random walk+ se&eral researchers ha&e concluded that8 #. stock prices re!lect a ma?orit o! a&ailable in!ormation about the !irm. 4. successi&e price changes are predictable. C. past stock price changes pro&ide little use!ul in!ormation about current stock prices. 9. stock prices alwas rise excessi&el in Januar.

10). # compan reports signi!icantl higher earnings on a onda. Iou purchase the stock on Tuesda and earn superior returns in the absence o! other new in!ormation. The market appears to be8 #. weak-!orm e!!icient at best. 4. weak-!orm e!!icient at the least. C. semistrong-!orm e!!icient at best. 9. strong-!orm e!!icient at the least.

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10,. Knder which o! the !ollowing !orms o! market e!!icienc would stock prices always re!lect !air &alue< #. :eak-!orm e!!icienc. 4. Semistrong-!orm e!!icienc. C. Strong-!orm e!!icienc. 9. #ll o! these are correct due to capital market e!!icienc.

10. Technical analsts are most likel to be success!ul in a market that is considered8 #. semistrong-!orm e!!icient. 4. not to be strong-!orm e!!icient. C. not to be weak-!orm e!!icient. 9. to !ollow a random walk.

10. *! the correlation o! prices between two stocks is 0.)+ then the price o! one stock would be expected to8 #. rise when the other stock price !alls. 4. rise b )= when the other stock price is unchanged. C. !all when the other stock price !alls. 9. !all b )= when the other stock price is unchanged.

107. *! the price o! a stock !alls on , consecuti&e das o! trading+ then stock prices8 #. cannot be !ollowing a random walk. 4. can still be !ollowing a random walk. C. are almost certain to increase toda. 9. are almost certain to decrease toda.

103. #ccording to random-walk theor+ what are the odds that a stock will increase in price a!ter ha&ing increased on % consecuti&e das o! trading< #. 0.0= 4. 1%.= C. 0.0= 9. 100.0=

7-%1


105. :hat is the maximum gain a!ter two coin tosses !or a person who starts with ;1 i! the occurrence o! a head produces a 0= gain while the occurrence o! a tail produces a 0= loss< #. ;1.00 4. ;1.% C. ;1.7 9. ;%.%

110. :hich o! the !ollowing situations is most likel to occur toda !or a stock that went down in price esterda< #. The stock will increase in price. 4. The stock will decrease in price. C. The stock has a )0= chance o! decreasing in price. 9. The stock has no predictable price-change pattern.

111. *! a stock's price decreased during the past week+ what is the most likel prediction about this week's price change< #. rice will re&erse last week's loss and go up. 4. rice will continue last week's decline. C. rice will stand still until new in!ormation is released. 9. 2ither direction o! price change is e6uall likel.

11%. esearch indicates that the correlation coe!!icient between successi&e das' stock price changes is8 #. 6uite close to L1. 4. 6uite close to -1. C. 6uite close to (ero. 9. directl related to the stock's beta.

11). #n analst who relies on past ccles o! stock pricing to make in&estment decisions is8 #. per!orming !undamental analsis. 4. reling on strong-!orm market e!!icienc. C. assuming that the market is not weak-!orm e!!icient. 9. reling on the random walk o! stock prices.

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11,. *! it pro&es possible to make abnormal pro!its based on in!ormation regarding past stock prices+ then the market8 #. is weak-!orm e!!icient. 4. is not weak-!orm e!!icient. C. is semistrong-!orm e!!icient. 9. is strong-!orm e!!icient.

11. The stud o! published !inancial in!ormation on a compan in order to make in&estment decisions is known as8 #. technical analsis. 4. !undamental analsis. C. e!!icienc analsis. 9. random pricing analsis.

11. # !undamental analst8 #. relies on the same in!ormation as the technical analst+ but belie&es in the random walk. 4. studies a !irm's !inancial statements to determine pricing ine!!iciencies. C. belie&es that the market is strong-!orm e!!icient. 9. per!orms an unnecessar !unction+ since markets are e!!icient.

117. *! in&estors can consistentl pro!it !rom thorough reading o! published !inancial in!ormation+ then the market can+ at best+ be characteri(ed as8 #. weak-!orm e!!icient. 4. semistrong-!orm e!!icient. C. strong-!orm e!!icient. 9. all o! these.

113. *! no price change occurs in a stock on the da that it announces its next di&idend+ it can be assumed that8 #. the stock market is ine!!icient. 4. the di&idend was reduced. C. the market was expecting this in!ormation. 9. technical analsts are not !ollowing this stock.

7-%)


115. :hen in&estors are not capable o! making superior in&estment decisions on a continual basis based on past prices or public or pri&ate in!ormation+ the market is said to be8 #. weak-!orm e!!icient. 4. semistrong-!orm e!!icient. C. strong-!orm e!!icient. 9. !undamentall e!!icient.

1%0. :hich group o! in&estors is capable o! earning consistent+ superior pro!its i! !inancial markets are strong-!orm e!!icient< #. /nl technical analsts will be able to pro!it. 4. /nl !undamental analsts will be able to pro!it. C. /nl inside traders will be able to pro!it. 9. o one will be capable o! sustained+ superior pro!its.

1%1. $i&en that markets are e!!icient+ what is the most logical ex planation o! the !act that a port!olio manager can outper!orm the SM 00 b = annuall< #. The manager is an expert stock selector. 4. The manager has relied on insider in!ormation. C. Stocks do not !ollow a random-walk pattern. 9. The manager's results ha&e not been ad?usted !or the riskiness o! the port!olio.

1%%. :hen new in!ormation becomes a&ailable in the market+ e&idence suggests that8 #. insiders will be the onl in&estors to gain. 4. it takes at least 10 trading das !or stock prices to ad?ust. C. stock prices will ad?ust to the in!ormation rapidl. 9. transaction costs will erase an bene!it o! trading on the in!ormation.

1%). #n example that speci!icall contradicts strong-!orm market e!!icienc in K.S. stock markets is that8 #. excess pro!its are obser&ed in cases o! insider trading. 4. stock prices !ollow predictable patterns in each month. C. random-walk beha&ior is reliable. 9. !undamental analsts outper!orm the SM 00.

7-%,


1%,. Iour broker suggests that ou can make consistent+ excess pro!its b purchasing stocks on the %0th o! the month and selling them on the last da o! the month. *! this is true+ then8 #. the market is onl semistrong-!orm e!!icient. 4. the market &iolates e&en weak-!orm e!!icienc. C. insiders will be the onl in&estors to pro!it. 9. prices !ollow a random walk.

1%. The statement that there are no !ree lunches on :all Street suggests that8 #. the market is strong-!orm e!!icient. 4. there is no return to technical or !undamental analsis. C. securit prices re!lect all a&ailable in!ormation. 9. !ood pur&eors are capitalists.

Essay Questions

1%. >ow can ou reconcile the !act that whether an in&estor !a&ors di&idends or capital gains+ the in&estor should accept the di&idend discount model as a determination o! share &alue<

1%7. # stock o!!ers an expected di&idend o! ;).0+ has a re6uired return o! 1,=+ and has historicall exhibited a growth rate o! =. *ts current price is ;). 00 and shows no tendenc to change. >ow can ou explain this price based on the constant growth di&idend discount model<

7-%


1%3. 9e&elop a current stock &alue !or a !irm that is expected to ha&e extraordinar growth o! %= !or , ears+ a!ter which it will !ace more competition and slip into a constant-growth rate o! =. *ts re6uired return is 1,= and next ear's di&idend is expected to be ;.00.

1%5. Show numericall that in&estment hori(on has no bearing on current stock price. or our illustration assume in&estment hori(ons o! ) &ersus  ears and the !ollowing !acts8 The stock is correctl priced at ;,0.00+ has a re6uired return o! 17=+ a growth rate o! 7=+ and has ?ust paid a ;).7, di&idend.

1)0. or a !irm that expects earnings next ear o! ;10.00 per share+ has a plowback ratio o! )=+ a return on e6uit o! %0=+ and a re6uired return o! 1=+ show the current stock &alue and next ear's expected stock &alue+ assuming that growth is to be constant.

7-%


1)1. Show the breakdown o! stock price between a !irm's assets that are alread in place and its present &alue o! growth opportunities+ assuming8 next ear's expected earnings e6ual ;.00+ 1)= re6uired rate o! return+ 17= return on e6uit+ and ,= plowback ratio.

1)%. >ow can an analst !eel com!ortable in stating that the &alue o! a stock is e6ual to the discounted &alue o! all !uture di&idends when a compan ma pa di&idends inde!initel and it is &irtuall impossible to predict di&idends beond some reasonable hori(on<

1)). $eothermal Corp. ?ust announced good news8 *ts earnings ha&e increased b %0=. ost in&estors had anticipated an increase o! %=. :ill $eothermal's stock price increase or decrease when the announcement is made<

7-%7


1),. 9iscuss Dwith !ormulaE the general di&idend discount model and its three ma?or submodels as introduced in the chapter.

1). oonshine *ndustries has produced a barrel per week !or the past %0 ears but cannot grow because o! certain legal ha(ards. *t earns ;% per share per ear and pas it all out to stockholders. The stockholders ha&e alternati&e+ e6ui&alent-risk &entures ielding %0= per ear on a&erage. >ow much is one share o! oonshine worth< #ssume the compan can keep going inde!initel.

1). :hat are some common errors in&estors make in assessing the probabilit o! uncertain outcomes< >ow did such errors rein!orce the dot-com boom<

7-%3


1)7. 2xplain wh the market &alue o! common stock o!ten di!!ers !rom its li6uidation &alue or its book &alue.

1)3. >ow do ou estimate expected rates o! return in the constant-growth di&idend discount model<

1)5. 2xplain the relationships among the earnings-price D2FE ratio+ re6uired rate o! return+ and present &alue o! growth opportunities.

1,0. >ow does competition among in&estors lead to e!!icient markets<

7-%5


1,1. :hat are index !unds and exchange-traded !unds< :h are man in&estors simpl choosing to bu and hold index !unds or exchange-traded port!olios D2TsE that track the entire stock market<

1,%. *s there a tall order when there are man talented and competiti&e !undamental analsts<

7-)0


Chapter 07 Valuing Stocks #nswer Ne

True / False Questions

1. The term "irrational exuberance" was coined b !ormer ed Chairman #lan $reenspan to describe the dot-com boom. TRUE

AACSB: Communication Abilities Blooms: Knowledge Difficulty:  !asy "earning #b$ecti%e: &'(& )nderstand the stoc* trading reports on the +nternet or in the financial pages of the newspaper, Topic: Stoc*s and the Stoc* -ar*et

%. The di&idend discount model indicates that the &alue o! a stock is the present &alue o! the di&idends it will pa o&er the in&estor's hori(on plus the present &alue o! the expected stock price at the end o! that hori(on. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

). *! in&estors belie&e a compan will ha&e the opportunit to make &er pro!itable in&estments in the !uture+ the will pa more !or the compan's stock toda. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: Stoc*s and the Stoc* -ar*et

7-)1


,. The di&idend discount model should not be used to &alue stocks in which the di&idend does not grow. FASE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

. $oogle's stock price tripling a!ter the */ suggests that &aluing growth stocks is an exact science. FASE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: Stoc*s and the Stoc* -ar*et

. Sustainable growth rates can be estimated b multipling a !irm's /2 b its di&idend paout ratio. FASE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

7. #ccording to the di&idend discount model+ a stock's price toda depends on the in&estor's hori(on !or holding the stock. FASE


7-)%


3. The di&idend ield o! a stock is much like the current ield o! a bond. 4oth ignore prospecti&e capital gains or losses. TRUE


5. The di&idend discount model states that toda's stock price e6uals the present &alue o! all expected !uture di&idends. TRUE

AACSB: Communication Abilities Blooms: Knowledge Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

10. #n excess o! market &alue o&er the book &alue o! e6uit can be attributed to going concern &alue. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: -ar*et3 Boo*3 and "i4uidation 0alues

11. Securities with the same expected risk should o!!er the same expected rate o! return. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: Stoc*s and the Stoc* -ar*et

7-))


1%. The li6uidation &alue o! a !irm is e6ual to the book &alue o! the !irm. FASE


1). arket price is not the same as book &alue or li6uidation &alue. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: -ar*et3 Boo*3 and "i4uidation 0alues

1,. arket &alue+ unlike book &alue and li6uidation &alue+ treats the !irm as a going concern. TRUE


1. #t each point in time all securities o! the same risk are priced to o!!er the same expected rate o! return. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: Stoc*s and the Stoc* -ar*et

7-),


1. *! the stock prices !ollow a random walk+ successi&e stock prices are not related. FASE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: Stoc*s and the Stoc* -ar*et

17. *! the stock prices !ollow a random walk+ successi&e stock price changes are not related. TRUE


13. *! the market is e!!icient+ stock prices should be expected to react onl to new in!ormation that is released. TRUE

AACSB: Communication Abilities Blooms: Knowledge Difficulty:  !asy "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: Stoc*s and the Stoc* -ar*et

15. The intent o! technical analsis is to disco&er patterns in past stock prices. TRUE

AACSB: Communication Abilities Blooms: Knowledge Difficulty:  !asy "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: -ar*et Analysis

7-)


%0. Technical analsts ha&e no e!!ect on the e!!icienc o! the stock market. FASE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: -ar*et Analysis

%1. Technical analsts would be more likel than other in&estors to index their port!olios. FASE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: -ar*et Analysis

%%. arket e!!icienc implies that securit prices impound new in!ormation 6uickl. TRUE

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: Stoc*s and the Stoc* -ar*et

%). *! the stock prices !ollow a random walk+ successi&e stock prices !luctuate abo&e and below a normal long-run price. FASE


7-)


%,. *! securit prices !ollow a random walk+ then on an particular da the odds are that an increase or decrease in price is e6uall likel. TRUE


%. undamental analsts attempt to get rich b identi!ing patterns in stock prices. FASE


%. Strong-!orm market e!!icienc implies that one could earn abo& e-a&erage returns b examining the histor o! a !irm's stock price. FASE


7-)7

Chapter 07 - Valuing Stocks Multiple Choice Questions

%7. The rise o! the dot-coms in the late 1550s is probabl due to8 #. in&estors reducing their expectations !rom common stocks. !" in&estors being reluctant to incur losses and being o&ercon!ident. C. a sharp impro&ement in the prospects !or di&idend growth. 9. the e!!icienc o! the markets.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(& )nderstand the stoc* trading reports on the +nternet or in the financial pages of the newspaper, Topic: Stoc*s and the Stoc* -ar*et

%3. :hat di&idend ield would be reported in the !inancial press !or a stock that currentl pas a ;1 di&idend per 6uarter and the most recent stock price was ;,0< #. %.= 4. ,.0= C" 10.0= 9. 1.0= ;1 di&idend per 6uarter G ;, annuall ;,F;,0 G 10= di&idend ield

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(& )nderstand the stoc* trading reports on the +nternet or in the financial pages of the newspaper, Topic: The Di%idend Discount -odel

7-)3


%5. :hich o! the !ollowing describes a seasoned o!!ering< #. #n */ o! common stock !or a well-known !irm. 4. #n */ that is o!!ered during the best buing season. C" #n additional e6uit issue !rom a publicl traded !irm. 9. #n shares traded in the secondar market are seasoned o!!erings.

AACSB: Communication Abilities Blooms: Knowledge Difficulty: / -edium "earning #b$ecti%e: &'(& )nderstand the stoc* trading reports on the +nternet or in the financial pages of the newspaper, Topic: Stoc*s and the Stoc* -ar*et

)0. :hich o! the !ollowing best characteri(es the di!!erence between growth stocks and income stocks< #. $rowth stocks do not pa di&idends. 4. *ncome stocks o!!er higher rates o! return. C. *ncome stocks are seasoned issues. #" $rowth stocks ha&e greater V$/.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(& )nderstand the stoc* trading reports on the +nternet or in the financial pages of the newspaper, Topic: Stoc*s and the Stoc* -ar*et

)1. *! The Wall Street Journal lists a stock's di&idend as ;1+ then it is most likel the case that the stock8 #. pas ;1 6uarterl+ or an estimated ;, annuall. !" pas ;0.% 6uarterl+ or an estimated ;1 annuall. C. paid ;1 during the past 6uarter+ with no !uture di&idends !orecast. 9. paid ;1 during the past ear+ with no !uture di&idends !orecast.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(& )nderstand the stoc* trading reports on the +nternet or in the financial pages of the newspaper, Topic: Stoc*s and the Stoc* -ar*et

7-)5


)%. >ow much should ou pa !or a share o! stock that o!!ers a constant-growth rate o! 10=+ re6uires a 1= rate o! return+ and is expected to sell !or ;0 one ear !rom now< #. ;,%.00 4. ;,.00 C" ;,., 9. ;,7.00 The easiest wa to sol&e this problem is to reali(e8 2xpected return G expected di&idend ield L expected capital appreciation Then8 .1 G .0 L expected capital appreciation .10 G expected capital appreciation #nd 6 1 G 110= o! 6 o ;0.00 G 1.1 6 o ;,., G 6 o

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: 1 7ard "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

)). >ow is it possible to ignore cash di&idends that occur !ar into the !uture when using a di&idend discount model< Those di&idends8 #. will be paid to a di!!erent in&estor. 4. will not be paid b the !irm. C" ha&e an insigni!icant present &alue. 9. ignore the tax conse6uences o! !uture di&idends.


7-,0


),. *! the di&idend ield !or ear 1 is expected to be = based on the current price o! ;%+ what will the ear , di&idend be i! di&idends grow at a constant =< #. ;1.)) #. ;1.)) !" ;1.,5 C. ;1.3 C. ;1.3 9. ;1.7 9. ;1.7 .0  ;% G ;1.% G 9*V1 Then+ 9*V, G ;1.%  D1.0E) G ;1.,5

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate Calculate the present %alue of a stoc* stoc* gi%en forecasts of future future di%idends and future future stoc* price, Topic: 0aluing Common Stoc*s

). The &alue o! common stock will likel decrease i!8 #. the #. the in&estment hori(on decreases. 4. the 4. the growth rate o! di&idends increases. C" the discount rate increases. 9. di&idends 9. di&idends are discounted back to the present.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate Calculate the present %alue of a stoc* stoc* gi%en forecasts of future future di%idends and future future stoc* price, Topic: 0aluing Common Stoc*s

). :hen &aluing stock with the di&idend discount model+ the present &alue o! !uture di&idends will8 #. change #. change depending on the time hori(on selected. !" remain constant regardless o! the time hori(on selected. C. remain C. remain constant regardless o! growth rate. 9. alwas 9. alwas e6ual the present &alue o! the terminal price.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate Calculate the present %alue of a stoc* stoc* gi%en forecasts of future future di%idends and future future stoc* price, Topic: The Di%idend Discount -odel

7-,1


)7. Common stock can be &alued using the perpetuit &aluation !ormula i! the8 #. discount #. discount rate is expected to remain constant. grow. !" di&idends are not expected to grow. C. growth C. growth rate in di&idends is not constant. 9. in&estor 9. in&estor does not intend to sell the stock.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate Calculate the present %alue of a stoc* stoc* gi%en forecasts of future future di%idends and future future stoc* price, Topic: 0aluing Common Stoc*s

)3. :hat should be the price !or a common stock paing ;).0 annuall in di&idends i! the growth rate is (ero and the discount rate is 3=< #. ;%%.3 #. ;%%.3 4. ;%3.00 4. ;%3.00 C. ;,%.00 C. ;,%.00 #" ;,).7

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate Calculate the present %alue of a stoc* stoc* gi%en forecasts of future future di%idends and future future stoc* price, Topic: The Di%idend Discount -odel

7-,%


)5. *! next ear's di&idend is !orecast to be ;.00+ the constant-growth rate is ,=+ and the discount rate is 1=+ then the current stock price should be8 #. ;)1.% #. ;)1.% 4. ;,0.00 4. ;,0.00 C" ;,1.7 9. ;,).)) 9. ;,).))

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate Calculate the present %alue of a stoc* stoc* gi%en forecasts of future future di%idends and future future stoc* price, Topic: The Di%idend Discount -odel

7-,)


,0. :hat price would ou expect to pa !or a stock with 1)= re6uired rate o! return+ ,= rate o! di&idend growth+ and an annual di&idend o! ;%.0 which will be paid tomorrow< #. ;%7.73 4. ;)0.%3 C. ;)1.10 #" ;)1.)5

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: 1 7ard "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-,,


,1. :hat constant-growth rate in di&idends is expected !or a stock &alued at ;)%.00 i! next ear's di&idend is !orecast at ;%.00 and the appropriate discount rate is 1)=< #. .00= 4. .%= C" .7= 9. 1.)3=

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-,


,%. #4C common stock is expected to ha&e extraordinar growth o! %0= per ear !or % ears+ at which time the growth rate will settle into a constant =. *! the discount rate is 1= and the most recent di&idend was ;%.0+ what should be the approximate current share price< #. ;)1.1 4. ;)).%) C" ;)7.,% 9. ;,7.77


,). # paout ratio o! )= !or a compan indicates that8 #. )= o! di&idends are plowed back !or growth. 4. = o! di&idends are plowed back !or growth. C. = o! earnings are paid out as di&idends. #" )= o! earnings are paid out as di&idends.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

7-,


,,. :hat would be the approximate expected price o! a stock when di&idends are expected to grow at a %= rate !or ) ears+ then grow at a constant rate o! =+ i! the stock's re6uired return is 1)= and next ear's di&idend will be ;,.00< #. ;1.0 4. ;%.03 C" ;3.% 9. ;75.,,


7-,7


,. :hat is the plowback ratio !or a !irm that has earnings per share o! ;1%.00 and pas out ;,.00 per share as di&idends< #. %.00= 4. )).))= C" .7= 9. 7.00=

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

,. :hat happens to a !irm that rein&ests its earnings at a rate e6ual to the !irm's re6uired return< A" *ts stock price will remain constant. 4. *ts stock price will increase b the sustainable growth rate. C. *ts stock price will decline unless di&idend paout ratio is (ero. 9. *ts stock price will decline unless plowback rate exceeds re6uired return.


7-,3


,7. :hat can be expected to happen when stocks ha&ing the same expected risk do not ha&e the same expected return< A" #t least one o! the stocks becomes temporaril mispriced. 4. This is a common occurrence indicating that one stock has more V$/. C. This cannot happen i! the shares are traded in an auction market. 9. The expected risk le&els will change until the expected returns are e6ual.


,3. 9i&idends that are expected to be paid !ar into the !uture ha&e8 #. great impact on current stock price due to their expected si(e. 4. e6ual impact on current stock price as near-term di&idends. C" lesser impact on current stock price due to discounting. 9. no impact on current stock price because the are uncertain.


,5. :hich o! the !ollowing is more likel to be responsible !or a !irm ha&ing low V$/< #. /2 exceeds re6uired return. 4. lowback is &er high. C" aout is &er high. 9. 4ook &alue o! e6uit is low.


7-,5


0. :hat is the most likel &alue o! the V$/ !or a stock with current price o! ;0+ expected earnings o! ; per share+ and a re6uired return o! %0=< #. ;10 !" ;%0 C. ;% 9. ;)0 :ith 100= paout ratio+ the stock would be &alued at ;)0 D;F.% G ;)0E. Thus+ the ;%0 o! additional price must represent V$/.


1. :hat is the expected constant-growth rate o! di&idends !or a stock with current price o! ;100+ expected di&idend pament o! ;10 per share+ and a re6uired return o! 1=< A" .00= 4. .%= C. 3.00= 9. 10.00= *! the ;10 di&idend were di&ided b .10+ it would e6ual the ;100 price. Thus+ = is the onl growth rate that will allow the denominator to e6ual .10.


7-0


%. :hich o! the !ollowing is least assured !or !irms that plowback a portion o! earnings into the !irm< #. $rowth in earnings per share 4. $rowth in di&idends per share C. $rowth in book &alue o! e6uit #" $rowth in stock price

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: 1 7ard "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

). :hat should be the price o! a stock that o!!ers a ;, annual di&idend with no prospects o! growth+ and has a re6uired return o! 1%.=< #. ;3.0 4. ;%.00 C" ;)%.00 9. ;0.00  G ;,F.1%  G ;)%

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty:  !asy "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-1


,. :hat should be the stock &alue one ear !rom toda !or a stock that currentl sells !or ;)+ has a re6uired return o! 1=+ an expected di&idend o! ;%.30+ and a constant di&idend growth rate o! 7=< A" ;)7., 4. ;)7.30 C. ;,0.% 9. ;,).0 ;)  1.07 G ;)7.,+ since di&idends+ price+ and book &alue grow at 7=


. :hat should be the current price o! a share o! stock i! a ; di&idend was ?ust paid+ the stock has a re6uired return o! %0=+ and a constant di&idend growth rate o! =< #. ;15.%) 4. ;%.00 C. ;).71 #" ;)7.3 6 G ;D1.0EFD.%0 - .0E 6 G ;.)0F.1, 6 G ;)7.3


7-%


. :hat should be the current price o! a stock i! the expected di&idend is ;+ the stock has a re6uired return o! %0=+ and a constant di&idend growth rate o! =< #. ;15.%) 4. ;%.00 C" ;).71 9. ;)7.3 6 G ;.00FD.%0 - .0E 6 G ;.00F.1, 6 G ;).71


7. ein&esting earnings into a !irm will not increase the stock price unless8 #. the new paradigm o! stock pricing is maintained. 4. true depreciation is less than reported depreciation. C. the !irm's di&idends are growing also. #" the /2 o! new in&estments exceeds the !irm's re6uired return.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: Stoc*s and the Stoc* -ar*et

7-)


3. >ow much o! a stock's ;)0 price is re!lected in V$/ i! it expects to earn ;, per share+ has an expected di&idend o! ;%.0+ and a re6uired return o! %0=< #. ;0 4. ;.00 C. ;3.00 #" ;10.00 6 G ;,F.% i! all earnings paid as di&idends 6 G ;%0A there!ore+ stock price is ;10 per share abo&e "no growth" &alue.


5. *n a &aluation o! a nonconstant di&idend growth stock+ the terminal &alue represents the8 #. point at which the present &alue o! !uture di&idends e6uals (ero. 4. maturit date o! the stock. C" present &alue o! !uture di&idends !rom that point on. 9. highest &alue that the stock will attain.


0. :hat stock price reaction would ou expect !rom a !irm that unexpectedl raises its di&idend permanentl and b a substantial amount< A" rice should rise+ gi&en di&idend discount models. 4. rice should decline+ gi&en discounted cash !low analsis. C. rice will remain constant+ due to market e!!icienc. 9. rice will remain constant+ due to random-walk beha&ior.


7-,


1. *n the calculation o! rates o! return on common stock+ di&idends are @@@@@@@ and capital gains are @@@@@. #. guaranteedA not guaranteed 4. guaranteedA guaranteed C" not guaranteedA not guaranteed 9. not guaranteedA guaranteed


%. :hich o! the !ollowing &alues treats the !irm as a going concern< A" arket &alue 4. 4ook &alue C. Bi6uidation &alue 9. one o! these


). The book &alue o! a !irm's e6uit is determined b8 #. multipling share price b shares outstanding. 4. multipling share price at issue b shares outstanding. C" the di!!erence between book &alues o! assets and liabilities. 9. the di!!erence between market &alues o! assets and liabilities.


7-


,. *! the li6uidation &alue o! a !irm is negati&e+ then8 A" the !irm's debt exceeds the market &alue o! assets. 4. the !irm's debt exceeds the book &alue o! e6uit. C. the book &alue o! assets exceeds the !irm's debt. 9. the market &alue o! assets exceeds the !irm's debt.


. # !irm's li6uidation &alue is the amount8 #. necessar to repurchase all shares o! common stock. !" reali(ed !rom selling all assets and paing o!! its creditors. C. a purchaser would pa !or the !irm in bankruptc. 9. e6ual to the book &alue o! e6uit.


. :hich o! the !ollowing is least likel to account !or an excess o! market &alue o&er book &alue o! e6uit< A" *naccurate depreciation methods 4. >igh rate o! return on assets C. The presence o! growth opportunities 9. Valuable o!!-balance sheet assets


7-


7. irms with &aluable intangible assets are more likel to show aDnE8 #. excess o! book &alue o&er market &alue o! e6uit. !" high going-concern &alue. C. low li6uidation &alue. 9. low F2 ratio.


3. :hich o! the !ollowing is inconsistent with a !irm that sells !or &er near book &alue< #. Bow current earning power 4. o intangible assets C" >igh !uture earning power 9. Bow+ unstable di&idend pament


5. The main purpose o! a market-&alue balance sheet is to8 #. show an in!lated &alue o! the !irm. 4. a&oid the recording o! certain liabilities. C" &alue assets and liabilities without $## restrictions. 9. impro&e the credit rating o! the !irm.


7-7


70. # stock paing ; in annual di&idends sells now !or ;30 and has an expected return o! 1,=. :hat might in&estors expect to pa !or the stock 1 ear !rom now< #. ;3%.%0 !" ;3.%0 C. ;37.%0 9. ;51.%0

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: 0aluing Common Stoc*s

71. :hich o! the !ollowing statements is correct about a stock currentl selling !or ;0 per share that has a 1= expected return and a 10= expected capital appreciation< #. *ts expected di&idend exceeds the actual di&idend. 4. *ts expected return will exceed the actual return. C" *t is expected to pa ;) in annual di&idends. 9. *t is expected to pa ;3 in annual di&idends. 2xpected return G expected di&idend ield L expected capital appreciation 1= G expected di&idend ield L 10= = G expected di&idend ield ;0 share price  = G ;) expected di&idend pament


7-3


7%. The expected return on a common stock is composed o!8 #. di&idend ield. 4. capital appreciation. C" both di&idend ield and capital appreciation. 9. capital appreciation minus the di&idend ield.


7). irms ha&ing a higher expected return ha&e a higher8 A" le&el o! expected risk. 4. di&idend ield. C. market &alue o! e6uit. 9. degree o! certaint concerning their returns.


7,. :hat is the expected di&idend to be paid in ) ears i! esterda's di&idend was ;.00+ di&idends are expected to grow at a constant = annual rate+ and the !irm has a 10= expected return< #. ;.7 !" ;7.1 C. ;7.30 9. ;5.)7 9*V) G 9*Vo  D1 L g E) G ;.00D1.0E) G ;7.1


7-5


7. 9i&iding a stock's earnings per share b the expected rate o! return will &alue the share correctl i! no new shares are issued and the di&idend ield8 #. exceeds the re6uired return. 4. e6uals the re6uired return. C" is (ero. 9. is constant.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: 1 7ard "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: The Di%idend Discount -odel

7. :hat rate o! return is expected !rom a stock that sells !or ;)0 per share+ pas ;1.0 annuall in di&idends+ and is expected to sell !or ;)) per share in one ear< #. .00= 4. 10.00= C. 1,.05= #" 1.00=


7-0


77. # compan with a return on e6uit o! 1= and a plowback ratio o! 0= would expect a constant-growth rate o!8 #. ,=. !" 5=. C. %1=. 9. %=. g G .1  .0 G .05 G 5=


73. :hat is the return on e6uit !or a !irm that has a constant di&idend growth rate o! 7= and a di&idend paout ratio o! 0=< #. %.30= 4. ,.%0= C. 11.7= #" 17.0= 7= G /2  plowback ratio G /2  D1 - .E G /2  ., 17.= G /2


7-1


75. # positi&e &alue !or V$/ suggests that the !irm has8 #. a positi&e return on e6uit. 4. a positi&e plowback ratio. C" in&estment opportunities with superior returns. 9. a high rate o! constant growth.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: 0aluing Common Stoc*s

30. :hich o! the !ollowing situations accuratel describes a growth stock+ assuming that each !irm has a re6uired return o! 1%=< #. # !irm with V$/ G ;0. 4. # !irm with in&estment opportunities ielding 10=. C" # !irm with in&estment opportunities ielding 1=. 9. #ll o! these !irms represent growth stocks.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: 0aluing Common Stoc*s

31. /ther things e6ual+ a !irm's sustainable growth rate could increase as a result o!8 A" increasing the plowback ratio. 4. increasing the paout ratio. C. decreasing the return on e6uit. 9. increasing total assets.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: 0aluing Common Stoc*s

7-%


3%. :hich o! the !ollowing is least likel to contribute to going concern &alue< A" >igh li6uidation &alue 4. 2xtra earning power C. uture in&estment opportunities 9. *ntangible assets


3). The terminal &alue o! a share o! stock8 #. is similar to the maturit &alue o! a bond. !" re!ers to the share &alue at the end o! the in&estor's holding period. C. is the &alue recei&ed b in&estors upon li6uidation o! the !irm. 9. is the price !or shares traded through a dealers' market.

AACSB: Communication Abilities Blooms: Knowledge Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: 0aluing Common Stoc*s

3,. :hich o! the !ollowing is true !or a !irm ha&ing a stock price o! ;,%+ an expected di&idend o! ;)+ and a sustainable growth rate o! 3=< A" *t has a re6uired return o! 1.1,=. 4. *t has a di&idend paout ratio o! )7.=. C. *t has an /2 o! 7.1,=. 9. *t has a plowback rate o! 7.1,=. ;,% G ;)FDr - .03E r G 1.1,=

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: The Di%idend Discount -odel

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3. :hat is the &alue o! the expected di&idend per share !or a stock that has a re6uired return o! 1=+ a price o! ;,+ and a constant-growth rate o! 1%=< A" ;1.30 4. ;).0 C. ;,.0 9. ;7.%0 ;, G 9*V1FD.1 - .1%E ;,  .0, G 9*V1 ;1.30 G 9*V1

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: The Di%idend Discount -odel

3. :hat is the re6uired return !or a stock that has a = constant-growth rate+ a price o! ;%+ an expected di&idend o! ;%+ and a F2 ratio o! 10< #. = 4. 10= C" 1,= 9. %%= ;% G %FDr - .0E r G 1,= DF2 ratio is a red herringE


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37. :hat is the minimum amount that shareholders should expect to recei&e in the e&ent o! a complete corporate li6uidation< #. arket &alue o! e6uit. 4. 4ook &alue o! e6uit. C" Hero. 9. Shareholders ma be re6uired to pay to be li6uidated.


33. The re6uired return on an e6uit securit is comprised o! a8 #. di&idend ield and /2. 4. current ield and a terminal &alue. C. sustainable growth rate and a plowback ield. #" di&idend ield and a capital gains ield.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: 0aluing Common Stoc*s

35. :hat proportion o! earnings is being plowed back into the !irm i! the sustainable growth rate is 3= and the !irm's /2 is %0=< #. 3= 4. 1%= C. %0= #" ,0= 3= G %0=  plowback ,0= G plowback


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50. :hat is the expected constant-growth rate o! di&idends !or a stock currentl priced at ;0+ that ?ust paid a di&idend o! ;,+ and has a re6uired return o! 13=< #. ).,1= 4. .0= C" 5.%= 9. 1%.= ;0 G ;,D1 L g EFD.13 - g E g G .05%

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: 1 7ard "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: The Di%idend Discount -odel

51. *! the li6uidation &alue o! a corporation exceeds the market &alue o! the e6uit+ then the8 A" !irm has no &alue as a going concern. 4. !irm's stock will sell !or book &alue. C. !irm is not taking ad&antage o! a&ailable growth opportunities. 9. di&idend paout ratio has been too high.


5%. #n in&estor is !aced with the decision o! whether to in&est in a stock with an expected return o! 1,= or a stock in the same industr with an expected %0= return. :hich o! the !ollowing seems most likel< #. The %0= stock is a better in&estment. 4. The 1,= stock is o&erpriced. C. 4oth stocks will ha&e approximatel the same return. #" 4oth stocks are priced correctl gi&en their percei&ed risk.


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5). *! a stock's F2 ratio is 1). at a time when earnings are ;) per ear+ what is the stock's current price< #. ;,.0 4. ;13.00 C. ;%%.%% #" ;,0.0 F2 G 1). 2 Then 6 G 1).  ;) rice G ;,0.0

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty:  !asy "earning #b$ecti%e: &'(&8 +nterpret price(earnings ratios, Topic: 0aluing Common Stoc*s

5,. :hat is the current price o! a share o! stock !or a !irm with ; million in balance-sheet e6uit+ 00+000 shares o! stock outstanding+ and a priceFbook &alue ratio o! ,< #. ;%.0 4. ;10.00 C. ;%0.00 #" ;,0.00 4ook &alue per share G ;+000+000F00+000 G ;10 *! priceFbook &alue G , Then price G ;10  , G ;,0

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&8 +nterpret price(earnings ratios, Topic: 0aluing Common Stoc*s

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5. #ssuming all o! the !ollowing !irms ha&e a re6uired return o! 1,=+ which would ou expect to ha&e a positi&e present &alue o! growth opportunities< A" # !irm with a F2 ratio o! 5. 4. # !irm with a F2 ratio o! . C. # !irm with an 2F ratio o! %0=. 9. one o! these !irms are expected to ha&e positi&e V$/. e6uired return O 2F ratio i! V$/ O 0 .1, O .1111

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&8 +nterpret price(earnings ratios, Topic: 0aluing Common Stoc*s

5. *n&estors are willing to purchase stocks ha&ing high F2 ratios because8 #. the expect these shares to sell !or a lower price. 4. the expect these shares to o!!er higher di&idend paments. C. these shares are accompanied b guaranteed earnings. #" the expect these shares to ha&e greater growth opportunities.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty:  !asy "earning #b$ecti%e: &'(&8 +nterpret price(earnings ratios, Topic: 0aluing Common Stoc*s

57. 4estirm has a 0-ear histor o! solid growth and e&er-increasing pro!its. *t is widel regarded as the leading !irm o! its industr. >ence+ 4estirm's stock8 #. should be a good bu. 4. cannot be a good bu. C" should be a sa!e bu. 9. cannot be a sa!e bu.

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: Stoc*s and the Stoc* -ar*et

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53. Book$ood+ *nc. has ?ust announced the bad news that its earnings ha&e dropped b )0=. *n !act+ its in&estors had anticipated e&en worse results Da decrease o! ,0=E. #s a result+ Book$ood's stock price8 A" increases. 4. remains the same. C. decreases. 9. !ollows a random walk as usual.

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: 1 7ard "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: Stoc*s and the Stoc* -ar*et

55. :hat is the di!!erence between a !undamental analst and a technical analst< #. /nl a !undamental analst belie&es markets are ine!!icient. 4. # technical analst !ocuses on !inancial statement analsis. C. /nl a technical analst helps keep the market e!!icient. #" # !undamental analst anal(es such in!ormation as earnings and asset &alues.

AACSB: Communication Abilities Blooms: Knowledge Difficulty: / -edium "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: -ar*et Analysis

100. :hich o! the !ollowing obser&ations pro&ides e&idence against strong-!orm market e!!icienc< #. Some mutual !unds outper!ormed the market in 1557. !" anagers trading in their own stock obtain superior returns. C. Iou cannot make superior pro!its b trading stocks a!ter earnings reports are issued. 9. Stock prices !ollow a random walk.


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101. #ccording to the semistrong !orm o! market e!!icienc+ when new in!ormation becomes a&ailable in the market8 #. stock prices will remain unchanged because the alread re!lect this in!ormation. !" stock prices will accuratel and rapidl ad?ust to re!lect this new in!ormation. C. stock prices will ad?ust to accuratel re!lect this new in!ormation o&er the course o! the next !ew das. 9. stock prices will most likel increase because all new in!ormation has a positi&e e!!ect on stock prices.


10%. :ith respect to the notion that stock prices !ollow a random walk+ se&eral researchers ha&e concluded that8 #. stock prices re!lect a ma?orit o! a&ailable in!ormation about the !irm. 4. successi&e price changes are predictable. C" past stock price changes pro&ide little use!ul in!ormation about current stock prices. 9. stock prices alwas rise excessi&el in Januar.


10). # compan reports signi!icantl higher earnings on a onda. Iou purchase the stock on Tuesda and earn superior returns in the absence o! other new in!ormation. The market appears to be8 A" weak-!orm e!!icient at best. 4. weak-!orm e!!icient at the least. C. semistrong-!orm e!!icient at best. 9. strong-!orm e!!icient at the least.

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: -ar*et Analysis

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10,. Knder which o! the !ollowing !orms o! market e!!icienc would stock prices always re!lect !air &alue< #. :eak-!orm e!!icienc. 4. Semistrong-!orm e!!icienc. C" Strong-!orm e!!icienc. 9. #ll o! these are correct due to capital market e!!icienc.


10. Technical analsts are most likel to be success!ul in a market that is considered8 #. semistrong-!orm e!!icient. 4. not to be strong-!orm e!!icient. C" not to be weak-!orm e!!icient. 9. to !ollow a random walk.


10. *! the correlation o! prices between two stocks is 0.)+ then the price o! one stock would be expected to8 #. rise when the other stock price !alls. 4. rise b )= when the other stock price is unchanged. C" !all when the other stock price !alls. 9. !all b )= when the other stock price is unchanged.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: 1 7ard "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: Stoc*s and the Stoc* -ar*et

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107. *! the price o! a stock !alls on , consecuti&e das o! trading+ then stock prices8 #. cannot be !ollowing a random walk. !" can still be !ollowing a random walk. C. are almost certain to increase toda. 9. are almost certain to decrease toda.


103. #ccording to random-walk theor+ what are the odds that a stock will increase in price a!ter ha&ing increased on % consecuti&e das o! trading< #. 0.0= 4. 1%.= C" 0.0= 9. 100.0=


7-7%


105. :hat is the maximum gain a!ter two coin tosses !or a person who starts with ;1 i! the occurrence o! a head produces a 0= gain while the occurrence o! a tail produces a 0= loss< #. ;1.00 !" ;1.% C. ;1.7 9. ;%.% 2nding wealth - beginning wealth G gain ;1.00D1.E% -;1.00 G gain ;%.% - ;1.00 G gain ;1.% G gain

AACSB: .eflecti%e Thin*ing S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&5 )nderstand what professionals mean when they say that there are no free lunches on Wall Street, Topic: 0aluing Common Stoc*s

110. :hich o! the !ollowing situations is most likel to occur toda !or a stock that went down in price esterda< #. The stock will increase in price. 4. The stock will decrease in price. C. The stock has a )0= chance o! decreasing in price. #" The stock has no predictable price-change pattern.


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111. *! a stock's price decreased during the past week+ what is the most likel prediction about this week's price change< #. rice will re&erse last week's loss and go up. 4. rice will continue last week's decline. C. rice will stand still until new in!ormation is released. #" 2ither direction o! price change is e6uall likel.


11%. esearch indicates that the correlation coe!!icient between successi&e das' stock price changes is8 #. 6uite close to L1. 4. 6uite close to -1. C" 6uite close to (ero. 9. directl related to the stock's beta.


11). #n analst who relies on past ccles o! stock pricing to make in&estment decisions is8 #. per!orming !undamental analsis. 4. reling on strong-!orm market e!!icienc. C" assuming that the market is not weak-!orm e!!icient. 9. reling on the random walk o! stock prices.


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11,. *! it pro&es possible to make abnormal pro!its based on in!ormation regarding past stock prices+ then the market8 #. is weak-!orm e!!icient. !" is not weak-!orm e!!icient. C. is semistrong-!orm e!!icient. 9. is strong-!orm e!!icient.


11. The stud o! published !inancial in!ormation on a compan in order to make in&estment decisions is known as8 #. technical analsis. !" !undamental analsis. C. e!!icienc analsis. 9. random pricing analsis.


11. # !undamental analst8 #. relies on the same in!ormation as the technical analst+ but belie&es in the random walk. !" studies a !irm's !inancial statements to determine pricing ine!!iciencies. C. belie&es that the market is strong-!orm e!!icient. 9. per!orms an unnecessar !unction+ since markets are e!!icient.


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117. *! in&estors can consistentl pro!it !rom thorough reading o! published !inancial in!ormation+ then the market can+ at best+ be characteri(ed as8 A" weak-!orm e!!icient. 4. semistrong-!orm e!!icient. C. strong-!orm e!!icient. 9. all o! these.


113. *! no price change occurs in a stock on the da that it announces its next di&idend+ it can be assumed that8 #. the stock market is ine!!icient. 4. the di&idend was reduced. C" the market was expecting this in!ormation. 9. technical analsts are not !ollowing this stock.


115. :hen in&estors are not capable o! making superior in&estment decisions on a continual basis based on past prices or public or pri&ate in!ormation+ the market is said to be8 #. weak-!orm e!!icient. 4. semistrong-!orm e!!icient. C" strong-!orm e!!icient. 9. !undamentall e!!icient.


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1%0. :hich group o! in&estors is capable o! earning consistent+ superior pro!its i! !inancial markets are strong-!orm e!!icient< #. /nl technical analsts will be able to pro!it. 4. /nl !undamental analsts will be able to pro!it. C. /nl inside traders will be able to pro!it. #" o one will be capable o! sustained+ superior pro!its.


1%1. $i&en that markets are e!!icient+ what is the most logical ex planation o! the !act that a port!olio manager can outper!orm the SM 00 b = annuall< #. The manager is an expert stock selector. 4. The manager has relied on insider in!ormation. C. Stocks do not !ollow a random-walk pattern. #" The manager's results ha&e not been ad?usted !or the riskiness o! the port!olio.


1%%. :hen new in!ormation becomes a&ailable in the market+ e&idence suggests that8 #. insiders will be the onl in&estors to gain. 4. it takes at least 10 trading das !or stock prices to ad?ust. C" stock prices will ad?ust to the in!ormation rapidl. 9. transaction costs will erase an bene!it o! trading on the in!ormation.


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1%). #n example that speci!icall contradicts strong-!orm market e!!icienc in K.S. stock markets is that8 A" excess pro!its are obser&ed in cases o! insider trading. 4. stock prices !ollow predictable patterns in each month. C. random-walk beha&ior is reliable. 9. !undamental analsts outper!orm the SM 00.


1%,. Iour broker suggests that ou can make consistent+ excess pro!its b purchasing stocks on the %0th o! the month and selling them on the last da o! the month. *! this is true+ then8 #. the market is onl semistrong-!orm e!!icient. !" the market &iolates e&en weak-!orm e!!icienc. C. insiders will be the onl in&estors to pro!it. 9. prices !ollow a random walk.


1%. The statement that there are no !ree lunches on :all Street suggests that8 #. the market is strong-!orm e!!icient. 4. there is no return to technical or !undamental analsis. C" securit prices re!lect all a&ailable in!ormation. 9. !ood pur&eors are capitalists.


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Chapter 07 - Valuing Stocks Essay Questions

1%. >ow can ou reconcile the !act that whether an in&estor !a&ors di&idends or capital gains+ the in&estor should accept the di&idend discount model as a determination o! share &alue< The !irst !act to be recogni(ed is that e6uall risk !irms should o!!er the same expected rate o! return. ext+ recogni(e that the return to a common stock in&estor can come !rom either di&idends or capital gains. Then it becomes easier to en&ision that+ !or example+ a !irm with a high paout ma o!!er good current income+ but that it will not be as likel to increase this income in the !uture due to the lower plowback now. /n the other hand+ a !irm with low or (ero current paout doesn't o!!er much in a ?usti!ication o! &alue !rom current income+ but is supposedl in&esting in growth opportunities that will someda o!!er enhanced paout potential. *n reconciling these cases+ common stock ma o!!er a di!!erent time pattern o! di&idends. That will o! course ha&e an e!!ect on present &alue+ but as long as in&estors with di!!erent pre!erences can agree on a stock's !undamentals+ the should place the same &alue on the stock8 the present &alue o! all expected !uture di&idends.

AACSB: Analytical S*ills Blooms: Analysis Difficulty: 1 7ard "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-75


1%7. # stock o!!ers an expected di&idend o! ;).0+ has a re6uired return o! 1,=+ and has historicall exhibited a growth rate o! =. *ts current price is ;). 00 and shows no tendenc to change. >ow can ou explain this price based on the constant growth di&idend discount model< The constant-growth di&idend discount model would indicate that this stock should currentl sell !or ;,).7+ based on the !ollowing !ormula8

#lthough stocks can temporaril be out o! e6uilibrium price+ the !act that this stock price shows no tendenc to change suggests that in&estors do not expect the past growth rate o! = to continue into the !uture. Since there is no indication that the re6uired rate o! return has changed+ it appears that the compan man anticipate !ewer positi&e growth opportunities than in the past. There!ore+ the di&idend ield has likel increased to its current 10= le&el+ and the o&erall market seems to expect a growth rate o! ,= rather than the historical =. #t a growth rate o! ,=+ the stock would be correctl priced at ;).00.

AACSB: Analytical S*ills Blooms: Analysis Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

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1%3. 9e&elop a current stock &alue !or a !irm that is expected to ha&e extraordinar growth o! %= !or , ears+ a!ter which it will !ace more competition and slip into a constant-growth rate o! =. *ts re6uired return is 1,= and next ear's di&idend is expected to be ;.00.

AACSB: Analytical S*ills Blooms: !%aluation Difficulty: 1 7ard "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

7-31


1%5. Show numericall that in&estment hori(on has no bearing on current stock price. or our illustration assume in&estment hori(ons o! ) &ersus  ears and the !ollowing !acts8 The stock is correctl priced at ;,0.00+ has a re6uired return o! 17=+ a growth rate o! 7=+ and has ?ust paid a ;).7, di&idend. ote that the &ariation between ;,0.01 and ;)5.53 is+ o! course+ a rounding error.

AACSB: Analytical S*ills Blooms: !%aluation Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: 0aluing Common Stoc*s

7-3%


1)0. or a !irm that expects earnings next ear o! ;10.00 per share+ has a plowback ratio o! )=+ a return on e6uit o! %0=+ and a re6uired return o! 1=+ show the current stock &alue and next ear's expected stock &alue+ assuming that growth is to be constant.

Thus+ both the di&idend discount model and the current stock price increase b g = indicate that next ear's &alue should be ;3.5,. This can be con!irmed b multipling the expected plowback o! ;).0 times the return on e6uit o! %0= to see that earnings should be 70 cents higher in % ears. This 70 cents will be sub?ect to a = paout+ which will increase di&idends b ,. cents. inall+ ,. cents translates into a price increase o! ;.3 when plugged into a di&idend discount model+ as can be seen b8

AACSB: Analytical S*ills Blooms: !%aluation Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-3)


1)1. Show the breakdown o! stock price between a !irm's assets that are alread in place and its present &alue o! growth opportunities+ assuming8 next ear's expected earnings e6ual ;.00+ 1)= re6uired rate o! return+ 17= return on e6uit+ and ,= plowback ratio.

AACSB: Analytical S*ills Blooms: !%aluation Difficulty: 1 7ard "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

1)%. >ow can an analst !eel com!ortable in stating that the &alue o! a stock is e6ual to the discounted &alue o! all !uture di&idends when a compan ma pa di&idends inde!initel and it is &irtuall impossible to predict di&idends beond some reasonable hori(on< #t most reasonable discount rates !or common stock+ sa between 10= and %0=+ the present &alue o! di&idends to be recei&ed beond some reasonable hori(on+ sa 10 ears+ is 6uite low in relation to the present &alue o! di&idends recei&ed to that point. or example+ !or a stock expecting to pa a di&idend o! ;%.00 with a growth rate o! = and a re6uired return o! 1=+ approximatel 0= o! the present &alue o! an infinite di%idend stream is reali(ed !rom the !irst 10 ears o! di&idends. 4 1 ears+ approximatel 7= o! !uture &alue has been recei&ed. These percentages can easil be pro&en b use o! the constant growth di&idend. discount model.

AACSB: Analytical S*ills Blooms: Analysis Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-3,


1)). $eothermal Corp. ?ust announced good news8 *ts earnings ha&e increased b %0=. ost in&estors had anticipated an increase o! %=. :ill $eothermal's stock price increase or decrease when the announcement is made< The stock price will decrease. The original price re!lects an anticipation o! a %= increase in earnings. The actual increase is a disappointment compared to original expectations.

AACSB: Analytical S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: Stoc*s and the Stoc* -ar*et

1),. 9iscuss Dwith !ormulaE the general di&idend discount model and its three ma?or submodels as introduced in the chapter. The di&idend discount model+ or discounted cash-!low model+ states that share &alue e6uals the present &alue o! all expected !uture di&idends. :ith a speci!ic in&estment time period or hori(on+ 73 the intrinsic share &alue D&alue determined b the e&idenceE is8

The stock price at the hori(on date+ 6 7 + is the present &alue o! cash di&idends recei&ed beond the hori(on date. #s the hori(on date changes+ the present &alue o! the stock will remain the same as di&idends are expected to grow at the rate o! r . #t extreme hori(on dates the present &alue o! 6 7 becomes insigni!icantA thus the di&idend discount model share &alue e6uals the present &alue o! !uture+ expected di&idends. The Di%idend Discount -odel with 9o rowth :hen all earnings are paid as cash di&idends+ no growth is possible Drein&estment G depreciation to maintain the current stock o! capitalE. The stock &alue o! a no-growth !irm is the expected di&idend capitali(ed DperpetuitE at the re6uired rate o! return or8

#ssuming all earnings are paid as di&idends+

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where 2S1 represents next ear's earnings per share. The Constant(rowth Di%idend Discount -odel The constant-growth discount model is an arithmetic expression calculating the present &alue o! a perpetual stream o! cash !lows+ 9*V+ growing at a constant rate o! growth+ g + and discounted at a re6uired rate o! return+ r 8

:ith a sustained positi&e growth rate in the econom and business acti&it+ the $ordon model and its assumptions are reasonable8 9*V1 represents the di&idend recei&ed at the end o! period one. The constant-growth !ormula is &alid onl when g is less than r . 6 0 is directl related to 9*V1 and g + and in&ersel related to r . The 9onconstant(rowth Di%idend Discount -odel The no-growth and constant-growth di&idend discount models assume two patterns o! cash !lows while realit presents the analst with man &ariations. The di&idend discount model is easil adapted. Changing !uture di&idend patterns !rom nongrowth to constant-growth to &ariable-growth rates o&er a gi&en hori(on re6uires that the analst estimate the stock price b !orecasting the cash-!low patterns and discounting the cash !lows at the market-re6uired rate o! return. The terminal &alue+ 6 7 3 represents the present &alue o! the cash !lows beond the hori(on.

AACSB: Communication Abilities Blooms: Knowledge Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

7-3


1). oonshine *ndustries has produced a barrel per week !or the past %0 ears but cannot grow because o! certain legal ha(ards. *t earns ;% per share per ear and pas it all out to stockholders. The stockholders ha&e alternati&e+ e6ui&alent-risk &entures ielding %0= per ear on a&erage. >ow much is one share o! oonshine worth< #ssume the compan can keep going inde!initel. Nnowing that all earnings are paid as di&idends+ we ha&e

where 2S1 represents next ear's earnings per share.

AACSB: Analytical S*ills Blooms: Application Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: The Di%idend Discount -odel

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1). :hat are some common errors in&estors make in assessing the probabilit o! uncertain outcomes< >ow did such errors rein!orce the dot-com boom< schologists ha&e !ound that when ?udging possible !uture outcomes+ indi&iduals commonl look back to what has happened in recent periods and then assume that this is representati&e o! what ma occur in the !uture. The temptation is to pro?ect recent experience into the !uture and to !orget the lessons learned !rom the more distant past. or example+ an in&estor who places too much weight on recent e&ents ma ?udge that glamorous growth companies are &er likel to continue to grow rapidl+ e&en though &er high rates o! growth cannot persist inde!initel. # second common bias is that o! o&ercon!idence. ost o! us belie&e that we are better-thana&erage dri&ers+ and most in&estors think that the are better-than-a&erage stockpickers. :e know that two speculators who trade with one another cannot both make mone !rom the dealA !or e&er winner there must be a loser. 4ut presumabl in&estors are prepared to continue trading because each is con!ident that it is the other one who is the pats. Iou can see how such beha&ior ma ha&e rein!orced the dot-com boom. #s the bull market de&eloped+ it generated increased optimism about the !uture and stimulated demand !or shares. The more that in&estors racked up pro!its on their stocks+ the more con!ident the became in their &iews and the more willing the became to bear the risk that the next month might not be so good.

AACSB: Analytical S*ills Blooms: Analysis Difficulty: / -edium "earning #b$ecti%e: &'(&/ Calculate the present %alue of a stoc* gi%en forecasts of future di%idends and future stoc* price, Topic: -ar*et Analysis

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1)7. 2xplain wh the market &alue o! common stock o!ten di!!ers !rom its li6uidation &alue or its book &alue. # !irm's li6uidation &alue represents the excess &aluation o! its assets o&er its liabilities i! the !irm ceased operations and all assets and liabilities were to be sold. /b&iousl+ then+ the li6uidation &alue will depend on the suppl and demand !or secondhand assets o! this nature. # !irm's book &alue o! e6uit e6uals all o! the initial !unds that were supplied b in&estors as well as earnings that ha&e been plowed back into the !irm o&er time. otice that this makes no statement as to how pro!itabl those earnings were rein&ested. :hen comparing either o! these &alues to a !irm's market &alue o! e6uit+ it is not surprising to !ind di!!erences. *! a !irm has been properl organi(ed and ser&es customer needs+ it will likel ha&e &alue as a going concern+ which ma easil boost market &alue higher than that o! li6uidation or book &alues. $oing-concern &alue can be the result o! extra earning power o&er that o! e6uall risk companies+ or intangible assets that o!!er unrecorded &alue+ or the &alue o! !uture in&estment opportunities.

AACSB: Analytical S*ills Blooms: Analysis Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: -ar*et3 Boo*3 and "i4uidation 0alues

7-35


1)3. >ow do ou estimate expected rates o! return in the constant-growth di&idend discount model< *n constant-growth business situations+ i! g is capitali(ed in the market in higher stock prices+ r ma be a prox !or the market expected rate o! return on similar risk situations. The expected rate o! return is a combination o! the di&idend ield+ 9*V 1F 6 0+ and capital appreciation rate+ g + or8

The re6uired rate o! return+ r + is a market-determined rate related to the risk-!ree rate ad?usted upward !or risk+ gi&en expectations o! 9*V1 and g . The stock price+ 6 0+ ad?usts to e6uate the market-expected rate with the re6uired rate o! return.

AACSB: Communication Abilities Blooms: Knowledge Difficulty: / -edium "earning #b$ecti%e: &'(&1 )se stoc* %aluation formulas to infer the e2pected rate of return on a common stoc*, Topic: The Di%idend Discount -odel

1)5. 2xplain the relationships among the earnings-price D2FE ratio+ re6uired rate o! return+ and present &alue o! growth opportunities. The in&erse o! the price-earnings DF2E ratio is the earnings-price D2FE ratio. *! the 2F ratio is greater than the re6uired return !or the stock+ the di!!erence is tpicall attributed to the !irm's positi&e &alue o! V$/. *!+ on the other hand+ the !irm's 2F ratio is e6ual to its re6uired rate o! return+ the !irm does not ha&e growth opportunities that are expected to ield more than the re6uired rate o! return gi&en the risk o! the stock. *t is possible that the !irm has a lower 2F ratio than the re6uired rate o! return+ in which case the !irm is not e&en earning the rate o! return that is re6uired !or its risk le&el. This is numericall e6ui&alent to the !irm ha&ing negati&e growth opportunities+ and suggests that the !irm either reorgani(e or li6uidate.

AACSB: .eflecti%e Thin*ing S*ills Blooms: )nderstanding Difficulty: / -edium "earning #b$ecti%e: &'(&8 +nterpret price(earnings ratios, Topic: 0aluing Common Stoc*s

7-50


1,0. >ow does competition among in&estors lead to e!!icient markets< The search !or in!ormation and insight!ul analsis makes in&estor assessments o! stock &alues as reliable as possible. Since the rewards accrue to the in&estors who unco&er rele&ant in!ormation before it is re!lected in stock prices+ competition among these in&estors means that there is alwas an acti&e search !or mispriced stocks. Competition between in&estors will tend to produce an e!!icient marketPthat is+ a market in which prices rapidl re!lect new in!ormation+ and in&estors ha&e di!!icult making consistentl superior returns. /! course+ we all hope to beat the market+ but i! the market is e!!icient+ all we can rationall expect is a return that is su!!icient on a&erage to compensate !or the time &alue o! mone and !or the risks we bear. The e!!icient market theor comes in three !la&ors. The weak !orm states that prices re!lect all the in!ormation contained in the past series o! stock prices. *n this case it is impossible to earn superior pro!its simpl b looking !or past patterns in stock prices. The semistrong !orm o! the theor states that prices re!lect all published in!ormation+ so that it is impossible to make consistentl superior returns ?ust b reading the newspaper+ looking at the compan's annual accounts+ and so on. The strong !orm states that stock prices e!!ecti&el impound all a&ailable in!ormation. This !orm tells us that pri&ate in!ormation is hard to come b+ because in pursuing it ou are in competition with thousandsPperhaps millionsPo! acti&e and intelligent in&estors. The best ou can do in this case is to assume that securities are !airl priced. The e&idence !or market e!!icienc is &oluminous and there is little doubt that skilled pro!essional in&estors !ind it di!!icult to win consistentl. e&ertheless+ there remain some pu((ling instances where markets do not seem to be e!!icient. Some !inancial economists attribute these apparent anomalies to beha&ioral !oibles.


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1,1. :hat are index !unds and exchange-traded !unds< :h are man in&estors simpl choosing to bu and hold index !unds or exchange-traded port!olios D2TsE that track the entire stock market< *ndex !unds in&est in all the stocks in the popular market indexes. or example+ the Vanguard *ndex 00 !und holds the stocks in the Standard M oor's Composite stock market index. DThe "SM 00" tracks the per!ormance o! the largest K.S. stocks. *t is the index most used b pro!essional in&estors.E *! ou bu this !und+ ou are insulated !rom the compan-speci!ic risks o! the 00 companies in the index. These risks are a&eraged out b di&ersi!ication. /! course ou are still le!t with the risk that the le&el o ! the stock market as a whole will !all. *ndex mutual !unds are one wa to in&est in widel di&ersi!ied port!olios at low cost. #nother route is pro&ided b 2Ts+ which are port!olios o! stocks that can be bought or sold in a single trade. These include Standard M oor's 9epositor eceipts DS9s+ or "spiders"E+ which are port!olios matching SM's stock market indexes. The total amount in&ested in the spider tracking the benchmark SM 00 index was about ;7 billion b the end o! %007. Iou can also bu 9*#/9S+ which track the 9ow Jones *ndustrial #&erageA QK42S or QQQQs+ which track the #S9#Q 100 indexA and Vanguard 2Ts+ which track the Vanguard Total Stock arket index+ a basket o! almost all the stocks traded in the Knited States. Iou can also bu 2Ts that track !oreign stock markets+ bonds+ or commodities. 2Ts are in some was more e!!icient than mutual !unds. To bu or sell an 2T+ ou simpl make a trade+ ?ust as i! ou bought or sold shares o! stock. To in&est in an open-ended mutual !und+ ou ha&e to send mone to the !und in exchange !or newl issued shares. *! ou want to withdraw the in&estment+ ou ha&e to noti! the !und+ which redeems our shares and sends ou a check or credits our account with the !und. #lso+ man o! the larger 2Ts charge lower !ees than mutual !unds. Vanguard's !ee !or managing its Total Stock arket 2T is . 07= per ear. or a ;100+000 in&estment+ the !ee is onl .0007  100+000 G ;70. an in&estors ha&e gi&en up the search !or superior in&estment returns. *nstead+ the simpl bu and hold index !unds or 2Ts that track the entire stock market and pro&ide maximum di&ersi!ication+ with &er low management !ees. :h pa higher !ees to managers who attempt to "beat the market" but can't do so consistentl< Corporate pension !unds now in&est o&er one-6uarter o! their K.S. e6uit holdings in index !unds.


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Chapter 7 - Test Bank

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