TB_Chapter08 Stocks and Their Valuation

CHAPTE CHAPTER R 8 STOCKS STO CKS AND TH THEIR EIR VALUAT VALUATION ION (Difficulty: (Difficulty: E = Easy, M = Medium, and T = Tough) Tough)

Multiple Choice: Conceptual Conceptual Easy: Required return 1.

Increase Increase. . Decrease Decrease. . Fluctuat Fluctuate. e. Remain Remain consta constant. nt. Possib Possibly ly increa increase, se, possib possibly ly decrea decrease, se, or possib possibly ly remain remain unchan unchanged ged. .

Required return

Answer: d

Diff: E

If the the expec expecte ted d rate rate of retur return n on a stoc stock k excee exceeds ds the the requi require red d rate, rate, a. b. c. d. e.

The stock stock is experi experienc encing ing super supernor normal mal growth growth. . The The stoc stock k shou should ld be sold sold. . The The comp compan any y is prob probab ably ly not not tryi trying ng to maxi maximi mize ze pric price e per per shar share. e. The The stoc stock k is a good good buy. buy. Divide Dividends nds are not being being declar declared. ed.

Required return 3.

Diff: E

An increase in a firm’s expected growth rate would normally cause the firm’s firm’s requir required ed rate rate of return return to a. b. c. d. e.

2.

Answer: e

Answer: a

Diff: E

Stoc Stock k A has has a requ requir ire ed return turn of 10 per percent cent. . Its div dividend dend is expe expect cted ed to to grow at a constant rate of 7 percent per year. Stock B has a required retu return rn of 12 perc percen ent. t. Its Its divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 9 perc percen ent t per per year year. . Stoc Stock k A has has a pric price e of $25 per per shar share, e, while while Stoc Stock k B has has a pric price e of $40 per shar share e. Whic Which h of the the foll ollowin owing g state tateme ment nts s is most ost correct? a. The The two two stoc stocks ks have have the the same same divi divide dend nd yiel yield. d. b. If the the stoc stock k mark market et were were effi effici cien ent, t, thes these e two two stoc stocks ks shou should ld have have the the same price. price. c. If the the stoc stock k mark market et were were effi effici cien ent, t, thes these e two two stoc stocks ks shou should ld have have the the same expected expected return. return. d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.

Chapter 8 - Page 1

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Constant growth model 4.

Answer: a

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is mos most t corre correct ct? ? a. The cons consta tant nt grow growth th mode model l take takes s into into cons consid ider erat atio ion n the the capi capita tal l gain gains s earn earned ed on a stoc stock. k. b. It is appr approp opri riat ate e to use use the the cons consta tant nt grow growth th mode model l to esti estima mate te stoc stock k value value even even if the growth growth rate rate never never become becomes s const constant ant. . c. Two Two firm firms s with ith the same same div dividen idend d and grow growth th rate rate must must also also have have the the same same stock stock price. price. d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.


Answer: a

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is mos most t corre correct ct? ? a. The The stoc stock k valu valuat atio ion n mode model, l, P0 = D1/(ks - g), g), can can be used used for for firm firms s whic which h have have negat negative ive growt growth h rates. rates. b. If a stock has a required rate of return ks = 12 percent, and its divi divide dend nd grow grows s at a cons consta tant nt rate rate of 5 perc percen ent, t, this this impl implie ies s that that the the stock’ stock’s s divid dividend end yield yield is 5 percen percent. t. c. Th The price of a stock is the present value of all expected future divide dividends nds, , discou discount nted ed at the divide dividend nd growth growth rate. rate. d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.


Diff: E

A stock’s dividend is expected to grow at a constant rate of 5 percent a year year. . Whic Which h of the the foll follow owin ing g stat statem emen ents ts is most most corr correc ect? t? a. b. c. d. e.

The The expe expect cted ed retu return rn on the the stoc stock k is 5 perc percen ent t a year year. . The The stoc stock’ k’s s divi divide dend nd yiel yield d is 5 perc percen ent. t. The The stoc stock’ k’s s pric price e one one year year from from now now is expe expect cted ed to be 5 perc percen ent t high higher er. . Stat Statem emen ents ts a and and c are are corr correc ect. t. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.


Answer: c

Answer: e

Diff: E

Stoc Stocks ks A and and B have have the the same same req require uired d rate ate of retu eturn and and the same same exp expecte ected d year year-e -end nd divi divide dend nd (D1). Stock A’s dividend is expected to grow at a cons consta tant nt rate rate of 10 perc percen ent t per per year year, , whil while e Stoc Stock k B’s B’s divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 5 perc percen ent t per per year year. . Whic Which h of the the foll follow owin ing g statem statement ents s is most most correc correct? t? a. The The two two stoc stocks ks shou should ld sell sell at the the same same pric price. e. b. Stoc Stock k A has has a high higher er divi divide dend nd yiel yield d than than Stoc Stock k B. c. Cu Currently Stock B has a higher price, but over eventu eventuall ally y have have a higher higher price. price. d. Stat Stat ts b d t.

time

Stock

A

will





















Constant growth stock 8.

Answer: c

Diff: E

N

Stoc Stock k X and Sto Stoc ck Y sell sell fo for the the sam same pric price e in toda today y’s mar marke ket t. Stock tock X has has a required return of 12 percent. Stock Y has a required return of 10 perc percen ent. t. Stoc Stock k X’s divi divid dend end is expe expec cted ted to grow grow at a con constan stant t rate ate of 6 perc percen ent t a year year, , whil while e Stoc Stock k Y’s Y’s divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 4 perc percen ent. t. Assu Assume me that that the the mark market et is in equi equili libr briu ium m and and expe expect cted ed retu return rns s equa equal l requ requir ired ed retu return rns. s. Whic Which h of the the foll follow owin ing g stat statem emen ents ts is most most correct? a. Stoc Stock k X has has a high higher er divi divide dend nd yiel yield d than than Stoc Stock k Y. b. Stoc Stock k Y has has a high higher er divi divide dend nd yiel yield d than than Stoc Stock k X. c. One One year year from from now, now, Stoc Stock k X’s X’s pric price e is expe expect cted ed to be high higher er than than Stoc Stock k Y’s price. price. d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. Stat Statem emen ents ts b and and c are are corr correc ect. t.


Diff: E

N

Stoc Stock k X is expe expec cted ted to pay pay a divi divid dend end of $3.0 $3.00 0 at the the end end of the the year year (tha (that t is, D1 = $3.0 $3.00) 0). . The The divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 6 perc percen ent t a year. ar. The stock tock curre urrent ntly ly trade rades s at a price ice of $50 $50 a share hare. . Assu Assume me that that the the stoc stock k is in equi equili libr briu ium, m, that that is, is, the the stoc stock’ k’s s pric price e equa equals ls its intrins intrinsic ic value. value. Which Which of the followi following ng statem statement ents s is most most correc correct? t? a. b. c. d. e.

The The requ requir ired ed retu return rn on the the stoc stock k is 12 perc percen ent. t. The The stoc stock’ k’s s expe expect cted ed pric price e 10 year years s from from now now is $89. $89.54 54. . The The stoc stock’ k’s s divi divide dend nd yiel yield d is 6 perc percen ent. t. Stat Statem emen ents ts a and and b are are corr correc ect. t. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.

Constant growth model 10 .

Answer: e

Answer: e

Diff: E

Stock X has a required return of 12 percent, a dividend yield of 5 perc percen ent, t, and and its its divi divide dend nd will will grow grow at a cons consta tant nt rate rate fore foreve ver. r. Stoc Stock k Y has has a requ requir ired ed retu return rn of 10 perc percen ent, t, a divi divide dend nd yiel yield d of 3 perc percen ent, t, and and its its divi divide dend nd will will grow grow at a cons consta tant nt rate rate fore foreve ver. r. Both Both stoc stocks ks curr curren entl tly y sell sell for for $25 $25 per per shar share. e. Whic Which h of the the foll follow owin ing g stat statem emen ents ts is most most corr correc ect? t? a. Stoc Stock k X pays pays a high higher er divi divide dend nd per per shar share e than than Stoc Stock k Y. b. Stoc Stock k X has has a lowe lower r expe expect cted ed grow growth th rate rate than than Stoc Stock k Y. c. One One year ear from rom now, ow, the the two stoc stocks ks are expe expec cted ted to trad trade e at the the same ame price. d. Stat Statem emen ents ts a and and b are are corr correc ect. t. e. Stat Statem emen ents ts a and and c are are corr correc ect. t.





















Constant growth model and CAPM 11.

Diff: E

N

Stock A has a beta of 1.1, while Stock B has a beta of 0.9. The market risk risk prem premiu ium, m, kM - kRF, is 6 perc ercent. ent. The ris risk-fr k-free ee rate rate is 6.3 perc perce ent. nt. Both Both stoc stocks ks have have a divi divide dend nd, , whic which h is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 7 perce ercent nt a year. ear. Assu Assume me that hat the the mark market et is in equil quilib ibri riu um. Which hich of the follow following ing statem statement ents s is most most correc correct? t? a. b. c. d. e.

Stoc Stock k A must must have have a high higher er divi divide dend nd yiel yield d than than Stoc Stock k B. Stoc Stock k A must must have have a high higher er stoc stock k pric price e than than Stoc Stock k B. Stock Stock B’s divide dividend nd yield yield equals equals its expect expected ed divide dividend nd growth growth rate. rate. Stat Statem emen ents ts a and and c are are corr correc ect. t. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.

Miscel Miscellan laneou eous s issues issues 12.

Answer: a

Answer Answer: : c

Diff: Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. If a comp compan any y has has two two clas classe ses s of comm common on stoc stock, k, Clas Class s A and and Clas Class s B, the the stoc stocks ks may may pay pay diff differ eren ent t divi divide dend nds, s, but but the the two two clas classe ses s must must have have the the same voting voting rights. rights. b. An IPO occurs whenever a company buys back its stock on the open market. c. The The pree preemp mpti tive ve righ right t is a prov provis isio ion n in the the corp corpor orat ate e char charte ter r that that give gives s comm common on stoc stockh khol olde ders rs the the righ right t to purc purcha hase se (on (on a pro pro rata rata basi basis) s) new new issues issues of common common stock stock. . d. Stat Statem emen ents ts a and and b are are corr correc ect. t. e. Stat Statem emen ents ts a and and c are are corr correc ect. t.

Preemptive right 13.

Answer: b

Diff: E

The The pree preemp mpti tive ve right right is impo import rtan ant t to share shareho hold lder ers s beca becaus use e it a. Allow Allows s mana manage geme ment nt to sell sell addi additi tion onal al shar shares es belo below w the the curr curren ent t mark market et price. b. Prote rotect cts s the curr urrent ent shar share ehold holder ers s again gainst st dilu diluti tion on of owne wnershi rship p interests. c. Is includ included ed in every every corpor corporate ate charte charter. r. d. Will Will resul result t in higher higher divide dividends nds per share. share. e. The preemp preemptiv tive e right right is not import important ant to share sharehol holder ders. s.

Classified stock 14. 14.

Answer: e

Companies can issue different classes of common stock. Which follow following ing statem statemen ents ts concer concernin ning g stock stock classe classes s is most most correc correct? t? a. b. c. d.

Diff: E of

the

All All comm common on stoc stocks ks fall fall into into one one of thre three e clas classe ses: s: A, B, and and C. Most Most firms firms have have severa several l classe classes s of commo common n stock stock outsta outstandi nding. ng. All common common stock, stock, regard regardles less s of class class, , must must have have voting voting rights rights. . All All comm common on stoc stock k, reg regardl ardles ess s of class lass, , must ust have ave the same same div dividen idend d privileges.





















Efficient markets hypothesis 15.

Answer: e

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. If a mark market et is stro strong ng-f -for orm m effi effici cien ent t this this impl implie ies s that that the the retu return rns s on bonds bonds and stocks stocks shoul should d be identi identical cal. . b. If If a market is weak-form efficient this implies that all public informat information ion is rapidly rapidly incorpor incorporated ated into market market prices. prices. c. If your your uncl uncle e earn earns s a retu return rn high higher er than than the the over overal all l stoc stock k mark market et, , this this means means the stock stock market market is ineff ineffici icient ent. . d. Stat Statem emen ents ts a and and b are are corr correc ect. t. e. None None of the the abov above e stat statem emen ents ts is corr correc ect. t.


Answer: d

Assu Assume me that that the stock stock marke market t is semis semistr tron ongg-fo form rm effic efficie ient nt. . followin following g statemen statements ts is most correct? correct?

Diff: E

Whic Which h of the

a. Stocks Stocks and bonds bonds shoul should d have have the same same expect expected ed return returns. s. b. In equi equili libr briu ium m all all stoc stocks ks shou should ld have have the the same same expe expect cted ed retu return rns, s, but but return returns s on stocks stocks should should exceed exceed retur returns ns on bonds. bonds. c. You You can can expe expect ct to outp outper erfo form rm the the over overal all l mark market et by obse observ rvin ing g the the past past price price histor history y of an indivi individu dual al stock. stock. d. For For the the aver averag age e inve invest stor or, , the the expe expect cted ed net net pres presen ent t valu value e from from inve invest stin ing g in the the stoc stock k mark market et is zero zero. . e. For For the the aver averag age e inve invest stor or, , the the expe expect cted ed net net pres presen ent t valu value e from from inve invest stin ing g in the the stoc stock k mark market et is the the requ requir ired ed retu return rn on the the stoc stock. k.


Answer: e

Assu Assume me that that the stock stock marke market t is semis semistr tron ongg-fo form rm effic efficie ient nt. . followin following g statemen statements ts is most correct? correct?

Diff: E

Whic Which h of the

a. Th The required rates of return on all stocks are the same and the requ requir ired ed rate rates s of retu return rn on stoc stocks ks are are high higher er than than the the requ requir ired ed rate rates s of retu return rn on bond bonds. s. b. The The requi equir red rates ates of retur eturn n on stoc stock ks equa equal l the requi equire red d rates ates of return return on bonds. bonds. c. A trad tradin ing g stra strate tegy gy in whic which h you you buy buy stoc stocks ks that that have have rece recent ntly ly fall fallen en in price rice is like likely ly to prov provi ide you you with ith retur eturns ns that that exce exceed ed the the rate ate of return return on the overa overall ll stock stock market market. . d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. None None of the the stat statem emen ents ts abov above e is corr correc ect. t.


Answer: e

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. If If the the stoc stock k mark market et is weak weak-f -for orm m effi effici cien ent, t, then then info inform rmat atio ion n abou about t recen ecent t trend rends s in stoc tock price rices s would ould be very very usef useful ul when when it come comes s to selectin selecting g stocks. stocks. b. If If the the stoc stock k mark market et is semi semist stro rong ng-f -for orm m effi effici cien ent, t, stoc stocks ks and and bond bonds s should should have have the same same expect expected ed return return. .






















Answer: c

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. Semi Semist stro rong ng-f -for orm m mark market et effi effici cien ency cy impl implie ies s that that all all priv privat ate e and and publ public ic informat information ion is rapidly rapidly incorpor incorporated ated into stock stock prices. prices. b. Mark Market et effi effici cien ency cy impl implie ies s that that all all stoc stocks ks shou should ld have have the the same same expe expect cted ed return. c. Weak Weak-f -for orm m mark market et effi effici cien ency cy impl implie ies s that that rece recent nt tren trends ds in stoc stock k pric prices es woul would d be of no use use in sele select ctin ing g stoc stocks ks. . d. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t. e. None None of the the stat statem emen ents ts abov above e is corr correc ect. t.


Answer: a

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. Semi Semist stro rong ng-f -for orm m mark market et effi effici cien ency cy mean means s that that stoc stock k pric prices es refl reflec ect t all all public information. information. b. An indi indivi vidu dual al who who has has info inform rmat atio ion n abou about t past past stoc stock k pric prices es shou should ld be able able to profi profit t from from this this inform informati ation on in a weak-f weak-form orm effici efficient ent market market. . c. An indi indivi vidu dua al who has has insi inside de inform format atio ion n abo about a publi ublicl cly y trade raded d comp compan any y shou should ld be able able to prof profit it from from this this info inform rmat atio ion n in a stro strong ng-f -for orm m efficien efficient t market. market. d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. All the state statemen ments ts above above are correc correct. t.


Answer: e

Diff: E

N

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. If a market rket is weak weak-f -for orm m effi fficien cient, t, this this mean means s that hat price rices s rapidl pidly y reflect reflect all availabl available e public public informat information. ion. b. If a mark market et is weak weak-f -for orm m effi effici cien ent, t, this this mean means s that that you you can can expe expect ct to beat beat the the mark market et by usin using g tech techni nica cal l anal analys ysis is that that reli relies es on the the char charti ting ng of past past price prices. s. c. If a mark market et is stro strong ng-f -for orm m effi effici cien ent, t, this this mean means s that that all all stoc stocks ks shou should ld have have the same same expec expected ted retur return. n. d. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t. e. None None of the the stat statem emen ents ts abov above e is corr correc ect. t.


Answer: a

Diff: E

Most Most stud studie ies s of stoc stock k mark market et effi effici cien ency cy sugg sugges est t that that the the stoc stock k mark market et is highly efficient in the weak form and reasonably efficient in the semi semist stro rong ng form form. . On the the basi basis s of thes these e find findin ings gs whic which h of the the foll follow owin ing g statemen statements ts is correct? correct? a. Info Inform rmat atio ion n you you read read in The today y cann cannot ot be used used to The Wall Wall Street Street Journa Journal l toda select select stocks stocks that that will will consis consisten tently tly beat beat the market market. . b. Th The stock price for a company has been increasing for the past 6 mont months hs. . On the basis asis of this his infor nform matio ation n it must must be true rue that hat the the stock stock price price will will also also increa increase se during during the curren current t month. month.























Preferred stock concepts 23.

Answer: e

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. Preferre Preferred d stockhol stockholders ders have priority priority over common common stockhol stockholders ders. . b. A big big adva advant ntag age e of pref prefer erre red d stoc stock k is that that pref prefer erre red d stoc stock k divi divide dend nds s are tax deduc deductib tible le for the issuin issuing g corpo corporat ration ion. . c. Most Most prefe preferre rred d stock stock is owned owned by corpor corporati ations ons. . d. Stat Statem emen ents ts a and and b are are corr correc ect. t. e. Stat Statem emen ents ts a and and c are are corr correc ect. t.

Preferred stock concepts 24.

Answer: e

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. One One of the the adva advant ntag age es to the firm irm asso associ cia ated ted with with prefe referr rre ed stoc stock k fina financ ncin ing g rath rather er than than comm common on stoc stock k fina financ ncin ing g is that that cont contro rol l of the the firm firm is not not dilute diluted. d. b. Prefer Preferred red stock stock provid provides es steadi steadier er and more more reliab reliable le incom income e to invest investors ors than than commo common n stock. stock. c. One One of the the adva advant ntag ages es to the the firm firm of fina financ ncin ing g with with pref prefer erre red d stoc stock k is that that 70 perc percen ent t of the the divi divide dend nds s paid paid out out are are tax tax dedu deduct ctib ible le. . d. Stat Statem emen ents ts a and and c are are corr correc ect. t. e. Stat Statem emen ents ts a and and b are are corr correc ect. t.

Common stock concepts 25.

Answer: d

Diff: E

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. One One of the advantages of common stock financing is that a greater prop propor orti tion on of stoc stock k in the the capi capita tal l stru struct ctur ure e can can redu reduce ce the the risk risk of a takeover takeover bid. b. A firm firm with with clas classi sifi fied ed stoc stock k can can pay pay diff differ eren ent t divi divide dend nds s to each each clas class s of shares shares. . c. One One of the the adva advant ntag ages es of comm common on stoc stock k fina financ ncin ing g is that that a firm firm’s ’s debt debt ratio ratio will decrease decrease. . d. Stat Statem emen ents ts b and and c are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.

Common stock concepts

Answer: e

Diff: E





















Declining growth stock 27. 27.

Answer: e

Diff: E

A stoc stock k expec xpect ts to pay pay a year ear-end -end div divide idend of $2.0 $2.00 0 a share hare (D1 = $2.00) $2.00). . The The divi divide dend nd is expe expect cted ed to fall fall 5 perc percen ent t a year year, , fore foreve ver r (g = -5%) -5%). . The The comp compan any’ y’s s expe expect cted ed and and requ requir ired ed rate rate of retu return rn is 15 perc percen ent. t. Whic Which h of the the followin following g statemen statements ts is most correct? correct? a. The The comp compan any’ y’s s stoc stock k pric price e is $10. $10. b. The The company’s expected dividend yield 5 years from now will be percent. c. The The comp compan any’ y’s s stoc stock k pric price e 5 year years s from from now now is expe expect cted ed to be $7.7 $7.74. 4. d. Stat Statem emen ents ts b and and c are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.

Dividend yield and g 28.

Diff: E

If two two cons consta tant nt growt growth h stoc stocks ks have have the same same requi require red d rate rate of retu return rn and and the the same same price price, , which which of the follow following ing statem statement ents s is most most correc correct? t? a. b. c. d.

The The two two stoc stocks ks have have The The two two stoc stocks ks have have The The two two stoc stocks ks have have The The stoc stock k with with the growth growth rate. rate. e. The stoc stock k with with the the growth growth rate. rate.

Dividend yield and g 29. 29.

Answer: d

20

the the same same perper-sh shar are e divi divide dend nd. . the the same same divi divide dend nd yiel yield. d. the the same same divi divide dend nd grow growth th rate rate. . high higher er div dividen idend d yiel ield will ill have ave a lower ower divi divid dend end high higher er divi divide dend nd yiel yield d will will have have a high higher er divi divide dend nd

Answer: c

Diff: E

Stoc Stocks ks A and and B have have the the same pric price, e, but but Stoc tock A has has a high higher er requ requi ired red rate ate of retu return rn than than Stoc Stock k B. Whic Which h of the the foll follow owin ing g stat statem emen ents ts is most most corr correc ect? t? a. Stoc Stock k A must must have have a high higher er divi divide dend nd yiel yield d than than Stoc Stock k B. b. Stoc Stock k B must must have have a high higher er divi divide dend nd yiel yield d than than Stoc Stock k A. c. If Stock A has a lower dividend yield than Stock B, its expected capi capita tal l gain gains s yiel yield d must must be high higher er than than Stoc Stock k B’s. B’s. d. If Stock A has a higher dividend yield than Stock B, its expected capi capita tal l gain gains s yiel yield d must must be lowe lower r than than Stoc Stock k B’s. B’s. e. Sto Stock A must ust have ave both oth a high highe er div dividen idend d yield ield and and a high igher capita pital l gain gains s yiel yield d than than Stoc Stock k B.





















Medium: Medium: Market Market effic efficien iency cy and stock stock retur returns ns 31.

Answer Answer: : c

Diff: Diff: M

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. If a stoc stock’ k’s s beta beta incr increa ease sed d but but its its grow growth th rate rate rema remain ined ed the the same same, , then then the new equilibrium price of the stock will be higher (assuming divide dividends nds contin continue ue to grow grow at the consta constant nt growth growth rate). rate). b. Mark Market et effi effici cien ency cy says says that that the the actu actual al real realiz ized ed retu return rns s on all all stoc stocks ks will will be equa equal l to the the expe expect cted ed rate rates s of retu return rn. . c. An implication of the semistrong form of the efficient markets hypo hypoth thes esis is is that that you you cann cannot ot cons consis iste tent ntly ly bene benefi fit t from from trad tradin ing g on informat information ion reported reported in The Wall Wall Street Street Journa Journal l. d. Stat Statem emen ents ts a and and b are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.


Answer: e

Diff: M

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. If the the stoc stock k mark market et is weak weak-f -for orm m effi effici cien ent t this this mean means s you you cann cannot ot use use private private informat information ion to outperfo outperform rm the market. market. b. If the the stoc stock k mark marke et is semis emistr tro ong-f ng-for orm m effi effic cient ient, , this this means ans the the expe expect cted ed retu return rn on stoc stocks ks and and bond bonds s shou should ld be the the same same. . c. If the the stoc stock k mark market et is semi semist stro rong ng-f -for orm m effi effici cien ent, t, this this mean means s that that high highbeta beta stock stocks s should should have have the same same expect expected ed return return as low-be low-beta ta stock stocks. s. d. Stat Statem emen ents ts b and and c are are corr correc ect. t. e. None None of the the stat statem emen ents ts abov above e is corr correc ect. t.


Answer: c

Diff: M

If the the stoc stock k mark market et is semi semist stro rong ng-f -for orm m effi effici cien ent, t, whic which h of the the foll follow owin ing g statem statement ents s is most most correc correct? t? a. All All stoc stocks ks shou should ld have have the the same same expe expect cted ed retu return rns; s; howe howeve ver, r, they they may may have differen different t realized realized returns. returns. b. In equili equilibri brium, um, stocks stocks and bonds bonds should should have have the same same expect expected ed return returns. s. c. Inve Invest stor ors s can can outp outper erfo form rm the the mark market et if they they have have acce access ss to info inform rmat atio ion n that that has not yet been been public publicly ly reveal revealed. ed. mi






















Answer: d

Assu Assume me that that mark market ets s are are semi semist stro rong ng-f -for orm m effi effici cien ent, t, but but not not effici efficient ent. . Which Which of the followi following ng statem statement ents s is most most correc correct? t?

Diff: M

stro strong ng-f -for orm m

a. Each Each comm common on stoc stock k has has an expe expect cted ed retu return rn equa equal l to that that of the the over overal all l market. b. Bond Bonds s and and stoc stocks ks have have the the same same expe expect cted ed retu return rn. . c. Inve Invest stor ors s can can expe expect ct to earn earn retu return rns s abov above e thos those e pred predic icte ted d by the the SML SML if they they have have access access to publi public c inform informati ation. on. d. Inve Invest stor ors s may may be able able to earn earn retu return rns s abov above e thos those e pred predic icte ted d by the the SML SML if they they have have access access to infor informat mation ion that that has not not been been publi publicly cly revea revealed led. . e. Stat Statem emen ents ts b and and c are are corr correc ect. t.

Market Market equil equilibr ibrium ium 36.

Answer Answer: : a

Diff: Diff: M

For markets to be in equilibrium, that is, for there to be no strong pressu pressure re for price prices s to depart depart from from their their curren current t level levels, s, a. The The expected rate of return must be equal to the required rate of return return; ; that that is, k = k. k. b. The The past past real realiz ized ed rate rate of retu return rn must must be equa equal l to the the expe expect cted ed rate rate of retu return rn; ; that that is, is, k = k . c. The The requ requi ired red rate ate of retu return rn must ust equal qual the real realiz ize ed rate ate of retu eturn; rn; that is, k = k . d. All All thre three e of the the stat statem emen ents ts abov above e must must hold hold for for equi equili libr briu ium m to exis exist; t; that that is, k = k = k . e. None None of the the stat statem emen ents ts abov above e is corr correc ect. t. 





Ownership and going public 37.

Answer: c

Diff: M

Whic Which h of the the foll follow owin ing g stat statem emen ents ts is fals false? e? a. Whe When n a cor corpora porati tion on’ ’s shar shares es are are owne owned d by a few few indiv ndivid idua ual ls who who are are asso associ ciat ated ed with with or are are the the firm firm’s ’s mana manage geme ment nt, , we say say that that the the firm firm is “closely “closely held.” held.” b. A publ public icly ly owne owned d corp corpor orat atio ion n is simp simply ly a comp compan any y whos whose e shar shares es are are held held by the the invest vestin ing g publi ublic c, which hich may may inclu nclude de othe other r corpo orpor ratio ations ns and and institut institutions ions as well as individu individuals. als.





















Dividend yield and g 38.

Answer: b

Diff: M

Whic Which h of the the follo followi wing ng stat statem emen ents ts is most most corre correct ct? ? a. Assu Assume me that that the the requ requir ired ed rate rate of retu return rn on a give given n stoc stock k is 13 perc percen ent. t. If the the stoc stock’ k’s s divi divide dend nd is grow growin ing g at a cons consta tant nt rate rate of 5 perc percen ent, t, its its expect expected ed divide dividend nd yield yield is 5 percen percent t as well. well. b. The The divi divide dend nd yiel yield d on a stoc stock k is equa equal l to the the expe expect cted ed retu return rn less less the the expected expected capital capital gain. gain. c. A stoc stock’ k’s s divi divide dend nd yiel yield d can can neve never r exce exceed ed the the expe expect cted ed grow growth th rate rate. . d. Stat Statem emen ents ts b and and c are are corr correc ect. t. e. All All of the the stat statem emen ents ts abov above e are are corr correc ect. t.


Answer: d

Diff: M

The The expe expect cted ed rate rate of retur return n on the commo common n stoc stock k of North Northwe west st Corpo Corpora rati tion on is 14 perc percen ent. t. The The stoc stock’ k’s s divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 8 perc percen ent t a year year. . The The stoc stock k curr curren entl tly y sell sells s for for $50 $50 a shar share. e. Whic Which h of the the followin following g statemen statements ts is most correct? correct? a. b. c. d. e.

The The The The The The The The The The

stoc stock’ k’s s divi divide dend nd yiel yield d is 8 perc percen ent. t. stoc stock’ k’s s divi divide dend nd yiel yield d is 7 perc percen ent. t. curr curren ent t divi divide dend nd per per shar share e is $4.0 $4.00. 0. stoc stock k pric price e is expe expect cted ed to be $54 $54 a shar share e in one one year year. . stoc stock k pric price e is expe expect cted ed to be $57 $57 a shar share e in one one year year. .

Multiple Multiple Choice: Choice: Problem Problemss Easy: Easy: Preferred stock value 40.

Answer: d

Diff: E

The The Jone Jones s Comp Compan any y has has deci decide ded d to unde undert rtak ake e a larg large e proj projec ect. t. Cons Conseq eque uent ntly ly, , ther there e is a need need for for addi additi tion onal al fund funds. s. The The fina financ ncia ial l mana manage ger r plan plans s to issu issue e pref prefer erre red d stoc stock k with with a perp perpet etua ual l annu annual al divi divide dend nd of $5 per per shar share e and and a par par value of $30. If the required return on this stock is currently 20 percen percent, t, what what should should be the stock’ stock’s s market market value value? ? a. $150 $150 b. $100 $100 c. $ 50























Preferred stock yield 42. 42.

Diff: E

A share of preferred stock pays a quarterly dividend of $2.50. If the pric price e of this this pref prefer erre red d stoc stock k is curr curren entl tly y $50, $50, what what is the the nomi nomina nal l annu annual al rate rate of return return? ? a. b. c. d. e.

12% 12% 18% 18% 20% 20% 23% 23% 28% 28%

Preferred stock yield 43. 43.

Answer: c

Answer: a

Diff: E

A shar share e of pre prefer ferred red stoc stock k pays pays a divid ivide end of $0.5 $0.50 0 each each qua quarte rter. If you you are are will willin ing g to pay pay $20. $20.00 00 for for this this pref prefer erre red d stoc stock, k, what what is your your nomi nomina nal l (not (not effec effectiv tive) e) annua annual l rate rate of retur return? n? a. 10% 10% b. 8% c. 6% d. 12% 12% e. 14% 14%

Stock price 44. 44.

Answer: d

Diff: E

Assu Assume me that that you you plan plan to buy buy a shar hare of XYZ XYZ stoc stock k tod today and and to hold old it for for 2 year years. s. Your Your expe expect ctat atio ions ns are are that that you you will will not not rece receiv ive e a divi divide dend nd at the the d f Y 1 b t ill i di id d f $9 25 t th d f





















Future stock price--constant growth 46.

Diff: E

Alle Allegh ghen eny y Publ Publis ishi hing ng’s ’s stock stock is expec expecte ted d to pay pay a year year-e -end nd divid dividen end, d, D1, of $4.00. The dividend is expected to grow at a constant rate of 8 perc percen ent t per per year year, , and and the the stoc stock’ k’s s requ requir ired ed rate rate of retu return rn is 12 perc percen ent. t. Give Given n this this info inform rmat atio ion, n, what what is the the expe expect cted ed pric price e of the the stoc stock, k, eigh eight t years years from from now? now? a. b. c. d. e.

$200.0 $200.00 0 $185.0 $185.09 9 $171.3 $171.38 8 $247.6 $247.60 0 $136.8 $136.86 6

Future stock price--constant growth 47.

Answer: b

Answer: a

Diff: E

Wate Waters rs Corp Corpor orat atio ion n has has a stoc stock k pric price e of $20 $20 a shar share. e. The The stoc stock’ k’s s year year-e -end nd divi divide dend nd is expe expect cted ed to be $2 a shar share e (D1 = $2.0 $2.00) 0). . The The stoc stock’ k’s s requ requir ired ed rate rate of retu return rn is 15 perc percen ent t and and the the stoc stock’ k’s s divi divide dend nd is expe expect cted ed to grow grow at the the same same cons consta tant nt rate rate fore foreve ver. r. What What is the the expe expect cted ed pric price e of the the stoc stock k seven seven years years from from now? now? a. b. c. d. e.

$28 $28 $53 $53 $27 $27 $23 $23 $39 $39

Future stock price--constant growth

Answer: a

Diff: E






















5% 6% 7% 8% 9%

Constant growth stock

Answer: a

Diff: E

A shar share e of comm common on stoc stock k has has just just paid paid a divi divide dend nd of $2.0 $2.00. 0. If the the expe expect cted ed long-r long-run un growth growth rate rate for this this stock stock is 15 percen percent, t, and if inves investor tors s requir require e a 19 perc percen ent t rate rate of retu return rn, , what what is the the pric price e of the the stoc stock? k? a. b. c. d. e.

$57.50 $57.50 $62.25 $62.25 $71.86 $71.86 $64.00 $64.00 $44.92 $44.92

Constant growth stock 52. 52.

Diff: E

McKe McKenn nna a Moto Motors rs is expe expect cted ed to pay a $1.0 $1.00 0 perper-sh shar are e divi divide dend nd at the the end end of the the year year (D1 = $1.0 $1.00) 0). . The The stoc stock k sell sells s for for $20 $20 per per shar share e and and its its requ requir ired ed rate of return is 11 percent. The dividend is expected to grow at a cons consta tant nt rate rate, , g, fore foreve ver. r. What What is the the grow growth th rate rate, , g, for for this this stoc stock? k? a. b. c. d. e.

51.

Answer: b

Answer: e

Diff: E

Thames Inc.’s most recent dividend was $2.40 per share (D0 = $2.4 $2.40) 0). . The dividend is expected to grow at a rate of 6 percent per year The






















$0.8 $0.87 7 $0.9 $0.95 5 $1.0 $1.02 2 $0.9 $0.90 0 $1.0 $1.05 5


Answer: b

Diff: E

Gett Gettys ysbu burg rg Groc Grocer ers’ s’ stoc stock k is expe expect cted ed to pay pay a year year-e -end nd divi divide dend nd, , D1, of $2.0 $2.00 0 per per shar share. e. The The divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 5 perc percen ent, t, and and the stoc stock k has a req require uired d retur eturn n of 9 per percent cent. . What hat is the the expe expect cted ed pric price e of the the stoc stock k five five year years s from from toda today? y? a. b. c. d. e.

$67.00 $67.00 $63.81 $63.81 $51.05 $51.05 $ 0.64 .64 $60.83 $60.83


Diff: E

A stock with a required rate of return of 10 percent sells for $30 per shar share. e. The The stoc stock’ k’s s divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 7 percen percent t per year. year. What What is the expect expected ed year-e year-end nd divide dividend, nd, D1, on the the stoc stock? k? a. b. c. d. e.

55.

Answer: d

Answer: d

Diff: E

A stoc stock k is expe expec cted ted to have have a divi ividend dend per per shar share e of $0.6 $0.60 0 at the the end end of the the (D 0.60 0.60). ). Th divi divide dend nd is cted cted to at tant tant te of 7





















Noncon Nonconsta stant nt growth growth stock stock 58.

Diff: Diff: E

The The last last divi divide dend nd paid paid by Klei Klein n Comp Compan any y was was $1.0 $1.00. 0. Klei Klein’ n’s s grow growth th rate rate is expe expect cted ed to be a cons consta tant nt 5 perc percen ent t for for 2 year years, s, afte after r whic which h divi divide dend nds s are are expe expect cted ed to grow grow at a rate rate of 10 perc percen ent t fore foreve ver. r. Klei Klein’ n’s s requ requir ired ed rate rate of retu return rn on equi equity ty (ks) is 12 perce percent nt. . What What is the the curr curren ent t pric price e of Klein Klein’s ’s common common stock? stock? a. b. c. d. e.

$21.00 $21.00 $33.33 $33.33 $42.25 $42.25 $50.16 $50.16 $58.75 $58.75


Answer Answer: : d

Answer Answer: : d

Diff: Diff: E

Your company paid a dividend of $2.00 last year. The growth rate is expected to be 4 percent for 1 year, 5 percent the next year, then 6 perc percen ent t for for the the foll follow owin ing g year year, , and and then then the the grow growth th rate rate is expe expect cted ed to be a cons consta tant nt 7 perc percen ent t ther therea eaft fter er. . The The requ requir ired ed rate rate of retu return rn on equi equity ty (ks) is 10 perc percen ent. t. What What is the the curr curren ent t stoc stock k pric price? e? a. b. c. d. e.

$53.45 $53.45 $60.98 $60.98 $64.49 $64.49 $67.47 $67.47 $69.21 $69.21

Beta coefficient

Answer: b

Diff: E























FCF model for valuing stock 62. 62.

Answer: d

Diff: E

N

An analyst is trying to estimate the intrinsic value of the stock of Harkle Harkleroa road d Techno Technolog logies ies. . The analys analyst t estima estimates tes that that Harkle Harkleroa road’s d’s free free cash cash flow flow duri during ng the the next next year year will will be $25 $25 mill millio ion. n. The The anal analys yst t also also esti estima mate tes s that that the the comp compan any’ y’s s free free cash cash flow flow will will incr increa ease se at a cons consta tant nt rate rate of 7 perc percen ent t a year year and and that that the the comp compan any’ y’s s WACC WACC is 10 perc percen ent. t. Hark Harkle lero road ad has has $200 million of long-term debt and preferred stock, and 30 million outs outsta tand ndin ing g shar shares es of comm common on stoc stock. k. What What is the the esti estima mate ted d perper-sh shar are e pric price e of Harklero Harkleroad ad Technolo Technologies gies’ ’ common common stock? stock? a. b. c. d. e.

$ 1.67 .67 $ 5.24 .24 $18.37 $18.37 $21.11 $21.11 $27.78 $27.78





















Equilibrium stock price 65.

Answer: b

Diff: M

You You are are give given n the the foll follow owin ing g data data: :

    

The risk-fre risk-free e rate rate is 5 percen percent. t. The The requ requir ired ed retu return rn on the the mark market et is 8 perc percen ent. t. The The expe expect cted ed grow growth th rate rate for for the the firm firm is 4 perc percen ent. t. The The last last divi divide dend nd paid paid was was $0.8 $0.80 0 per per shar share. e. Beta Beta is 1.3. 1.3.

Now assume assume the follow following ing chang changes es occur: occur:

 The inflat inflation ion premi premium um drops drops by 1 percen percent. t.  An incr increa ease sed d degr degree ee of risk risk aver aversi sion on caus causes es the the requ requir ired ed retu return rn on the the 

mark market et to rise rise to 10 perc percen ent t afte after r adju adjust stin ing g for for the the chan change ged d infl inflat atio ion n premium. The expect expected ed growth growth rate rate increa increases ses to 6 percen percent. t. ri 1.5. 1.5.





















Noncon Nonconsta stant nt growth growth stock stock 68. 68.

Answer Answer: : a

Diff: Diff: M

Moto Motor r Home omes Inc. nc. (MHI) MHI) is prese resent ntly ly in a stag stage e of abno bnormal rmally ly hig high growt rowth h beca becaus use e of a surge rge in the the deman emand d for moto motor r homes omes. . The The com company pany expect pects s earnings and dividends to grow at a rate of 20 percent for the next 4 year years, s, afte after r whic which h time time ther there e will will be no grow growth th (g = 0) in earn earnin ings gs and and divi divide dend nds. s. The The comp compan any’ y’s s last last divid dividen end d was was $1.5 $1.50. 0. MHI’ MHI’s s beta beta is 1.6, 1.6, the retu return rn on the the mark market et is curr curren entl tly y 12.7 12.75 5 perc percen ent, t, and and the the risk risk-f -fre ree e rate rate is 4 perc percen ent. t. What What shou should ld be the the curr curren ent t comm common on stoc stock k pric price? e? a. b. c. d. e.

$15.17 $15.17 $17.28 $17.28 $22.21 $22.21 $19.10 $19.10 $24.66 $24.66

Noncon Nonconsta stant nt growth growth stock stock

Answer Answer: : d

Diff: Diff: M





















Noncon Nonconsta stant nt growth growth stock stock 71. 71.

Answer Answer: : a

Diff: Diff: M

R. E. Lee recently took his company public through an initial public offe offeri ring ng. . He is expa expand ndin ing g the the busi busine ness ss quic quickl kly y to take take adva advant ntag age e of an othe otherw rwis ise e unex unexpl ploi oite ted d mark market et. . Grow Growth th for for his his comp compan any y is expe expect cted ed to be 40 perc percen ent t for for the the firs first t thre three e year years s and and then then he expe expect cts s it to slow slow down down to a cons consta tant nt 15 perc percen ent. t. The The most most rece recent nt divi divide dend nd (D0) was was $0.7 $0.75. 5. Base Based d on the the most most rece recent nt retu return rns, s, his his comp compan any’ y’s s beta beta is appr approx oxim imat atel ely y 1.5. 1.5. The The risk riskfree free rate rate is 8 perc percen ent t and and the the mark market et risk risk prem premiu ium m is 6 perc percen ent. t. What What is the curren current t price price of Lee’s Lee’s stock? stock? a. b. c. d. e.

$77.14 $77.14 $75.17 $75.17 $67.51 $67.51 $73.88 $73.88 $93.20 $93.20






















Answer Answer: : b

Diff: Diff: M

McPh McPher erso son n Ente Enterp rpri rise ses s is plan planni ning ng to pay pay a divi divide dend nd of $2.2 $2.25 5 per per shar share e at the the end of the year ear (D1 = $2.2 $2.25) 5). . The The comp compan any y is plan planni ning ng to pay the the same same divi divide dend nd each each of the the foll follow owin ing g 2 year years s and and will will then then incr increa ease se the the divi divide dend nd to $3.00 for the subsequent 2 years (D4 an and D5). After that time the dividends will grow at a constant rate of 5 percent per year. If the requ requir ired ed retu return rn on the the comp compan any’ y’s s comm common on stoc stock k is 11 perc percen ent t per per year year, , what what is its curren current t stock stock price? price? a. b. c. d. e.

$52.50 $52.50 $40.41 $40.41 $37.50 $37.50 $50.00 $50.00 $32.94 $32.94

Noncon Nonconsta stant nt growth growth stock stock

Answer Answer: : b

Diff: Diff: M
























Answer Answer: : c

Diff: Diff: M

Whit Whites esel ell l Tech Techno nolo logy gy has just just paid paid a divi divide dend nd (D0) and and is expe expect cted ed to pay pay a $2.0 $2.00 0 per-s er-sh hare are divid ividen end d at the end of the the year ear (D1). The dividend is expe expect cted ed to gro grow 25 perce ercent nt a year ear for the the foll ollowin owing g four our year ears, (D5 = $2.00  (1.25)4 = $4.8 $4.882 828) 8). . Afte After r this this time time peri period od, , the the divi divide dend nd will will grow grow
























Answer Answer: : a

Diff: Diff: M

Lewi Lewisb sbur urg g Comp Compan any’ y’s s stoc stock k is expe expect cted ed to pay pay a divi divide dend nd of $1.0 $1.00 0 per per shar share e at the the end end of the the year year. . The The divi divide dend nd is expect pected ed to grow row 20 perc percen ent t per per year year each each of the the foll follow owin ing g thre three e year years s (D4 = $1.7 $1.728 280) 0), , afte after r whic which h time time the the divi divide dend nd is expe expect cted ed to grow grow at a cons consta tant nt rate rate of 7 perc percen ent t per per year year. . The The
























Answer Answer: : c

Diff: Diff: M

Garcia Inc. has a current dividend of $3.00 per share (D0 = $3.0 $3.00) 0). . Anal Analys ysts ts expe expect ct that that the the divi divide dend nd will will grow grow at a rate rate of 25 perc percen ent t a year year for for the the next next thre three e year years, s, and and ther therea eaft fter er it will will grow grow at a cons consta tant nt rate rate of 10 perc percen ent t a year year. . The The comp compan any’ y’s s cost cost of equi equity ty capi capita tal l is esti estima mate ted d to be























Supernormal growth stock 87.

Answer: b

Diff: M

ABC Company has been growing at a 10 percent rate, and it just paid a divi divide dend nd of D0 = $3.00. Due to a new product, ABC expects to achieve a dram dramat atic ic incr increa ease se in its its shor shortt-ru run n grow growth th rate rate, , to 20 perc percen ent t annu annual ally ly for for the the next 2 year years. s. Afte fter this his time time, , grow growth th is expect pected ed to retur eturn n to the the























Supernormal growth stock 90.

Answer: b

Diff: M

Assu Assume me that that the the aver averag age e firm firm in your your compa company ny’s ’s indus industr try y is expec expecte ted d to grow grow at a constant rate of 5 percent, and its dividend yield is 4 percent. Your company is about as risky as the average firm in the indu indust stry ry, , but but it has has just just deve develo lope ped d a line line of inno innova vati tive ve new new prod produc ucts ts, ,











































































































































































































































































































































































































































































































































































































85.

No Nonconstant growth stock Time line: line: 0 ks = 12% 12% | g = 25% s

P0

1.0 0 = ?

1 |

gs = 25%

1.25

Answer: a

2 |

gs = 25% 25%

1.5625

3 |

gs = 25% 25%

1.953 1

4 |

Diff: M

5 Y ears |

gn = 5%

2.4414

P4 = 36.6 36.621 211 1 =

N

2.5 635 2.5635

ˆ

CFt 0

1.25

1.5625

1.9531

0.12 - 0.05

3 9.062 5

Step Step 1:

Calc Calcul ulat ate e the the divi divide dend nds s duri during ng the the nonc noncon onst stan ant t grow growth th peri period od and and the first first divide dividend nd after after that that period period. . D1 = D0(1 + g) = $1.0 $1.00( 0(1. 1.25 25) ) = $1.2 $1.250 500. 0. D2 = D1(1 + g) = $1.2 $1.25( 5(1. 1.25 25) ) = $1.5 $1.562 625. 5. D3 = D2(1 + g) = $1.5 $1.562 625( 5(1. 1.25 25) ) = $1.9 $1.953 531. 1. D4 = D3(1 + g) = $1.9 $1.953 531( 1(1. 1.25 25) ) = $2.4 $2.441 414. 4. D5 = D4(1 + g) = $2.4 $2.441 414( 4(1. 1.05 05) ) = $2.5 $2.563 635. 5.

Step Step 2: 2:

Calc Calcul ulat ate e the the stoc stock k pric price e when when the the stoc stock’ k’s s grow growth th rate rate beco become mes s constant. P4 = D5/(ks – g) = $2.563 $2.5635/ 5/(0. (0.12 12 – 0.05) 0.05) = $36.6211 $36.6211. . ˆ

Step 3:

86.

Using your financial calculator, enter the cash flows to determin determine e the stock’s stock’s current current price. price. CF0 = 0; CF1 = 1.25 1.25; ; CF2 = 1.56 1.5625 25; ; CF3 = 1.95 1.9531 31; ; CF4 = 39.0 39.062 625; 5; I = 12. 12. Solv Solve e for for NPV NPV = $28. $28.57 5768 68  $28.58.

Supernormal growth stock

Answer: e

Diff: M

The The data data in the the prob proble lem m are are unre unreal alis isti tic c and and inco incons nsis iste tent nt with with the the requ requir ireement ments s of the the grow growth th mode model; l; k less less than than g impl implie ies s a nega negati tive ve stoc stock k pric price. e. If k equals g, the denominator is zero, and the numerical result is unde undefi fine ned. d. k must must be grea greate ter r than than g for for a reas reason onab able le appl applic icat atio ion n of the the model.





















87.

Supernormal growth stock Time line: line: 0 ks = 15% 15% | g = 20%

1 |

s

3.00 P0 = ?

2 |

gs = 20% 20%

3.60

ˆ

CFt 0

gn = 10% 10%

4.32 P2

3.60

3 |

= 95.0 95.04 4 =

Answer: b

Diff: M

Answer: b

Diff: M

Years

4.7 52 4.752 0.15  0.10

99.36

ks = 0.07 0.07 + (0.1 (0.11 1 - 0.07 0.07)2 )2.0 .0 = 0.15 0.15 = 15%. 15%. Numerical solution: $3.60 $99.36 P0 = = $78.26 $78.26. .  2 1.15 (1.15) Dividend yield =

D1 P0



$3.60 $78.26

 4.60 %.

Financia Financial l calculat calculator or solution solution: : Inpu Inputs ts: : CF0 = 0 ; C F1 = 3.60 3.60; ; CF2 = 99.3 9.36; I = 15. Outp Output ut: : NPV NPV = $78. $78.26 26. . Divide Dividend nd yield yield = $3.60/ $3.60/$78 $78.26 .26 = 0.0460 0.0460 = 4.60%. 4.60%.

88.

Supernormal growth stock Time line: line: 0 ks = 18% 18% | g = 15% s

0 P0 = ?

1 |

2 |

3 |

0

0

2.0 0

gn = 6%

P3 = 17.6 17.667 67 = ˆ

CFt

0

0

0

4 Year s | 2.12 2.12

0.18  0.06

19. 667

Numerical solution: $0 $0 $19.667 P0     $11.97. 2 1.18 (1.18) (1.18)3 ˆ

P0  P0 . ˆ

Stoc Stock k is over overva valu lued ed: :

$15. $15.00 00 - $11. $11.97 97 = $3.0 $3.03. 3.

Financia Financial l calculat calculator or solution solution: : Calcul Calculate ate curren current t expect expected ed price price of stock, stock, P0 : Inpu Inputs ts: : CF0 = 0 ; C F1 = 0 ; Nj = 2; CF2 = 19.66 9.667; 7; I = 18. 18. Outp Output ut: : NPV NPV = $11. $11.97 97. . P0 = $11.97 $11.97. . ˆ

ˆ





















89.

Supernormal growth stock Step Step 1:

Answer: b

Diff: M

Draw Draw the the time time line line for for the the stoc stock: k: 0 1 2 3 4 Years ks = 12% 12% | | | | | gs = 25% gs = 25% 25% gn = 7% P0 = ? 1 .500 0 1.87500 2.34375 2.5078125 2.5078125 P3 = 50.1 50.156 5625 25 = 0.12  0.07 ˆ

Step Step 2:

Calc Calcul ulat ate e the the stoc stock’ k’s s divi divide dend nds s for for Year Years s 2-4: 2-4: D2 = $1.50 $1.50  1.25 1.25 = $1.875 $1.8750. 0. D3 = $1.875 $1.8750 0  1.25 1.25 = $2.343 $2.34375. 75. D4 = $2.34375 $2.34375  1.07 = $2.507 $2.507812 8125. 5.

Step Step 3:

Calc Calcul ulat ate e the the stoc stock’ k’s s expe expect cted ed price price in Year Year 3: P3 = D4/(ks - g) = $2.507 $2.507812 8125/( 5/(0.1 0.12 2 - 0.07) 0.07) = $50.1562 $50.15625. 5. ˆ

Step Step 4:

Calc Calcul ulat ate e the the valu value e of the the stoc stock k toda today: y: As an inves nvest tor tod today, ay, you will ill get get D1, D2, D3, and can sell the stoc stock k at t = 3 for for $50. $50.15 1562 625. 5. $1.50 $1.875 $2.34375  $50.15625 P0    2 3 1.12 (1.12) (1.12)

 $1.3393  $1.4947  $37.3685  $40.2025  $40.20. 90.


Answer: b

Time line: line: 0 |

ks = 9% g1 = 40%

1 |

2.00 P0 = ? CFt 0

P2 = ˆ

g2 = 25% 25%

2.80 3.675 0.09  0.05 2.8 0

2 |

gn = 5%

3.50 = 91.87 91.875 5 9 5.375

ks = Divi ividend dend yiel ield + g = 0.04 .04 + 0.0 0.05 + 0.09 0.09  9%. Numerical solution: $2.80 $95.375 P0    $82.84. 2 1.09 (1.09) Financia Financial l calculat calculator or solution solution: : Inpu Inputs ts: : CF0 = 0 ; C F1 = 2.80 2.80; ; CF2 = 95.3 5.375; 75; I = 9. Outp Output ut: : NPV NPV = $82. $82.84 84; ; P0 = $82.84 $82.84. .

3 |

Years

3.675

Diff: M





















91.

Declining growth stock

Answer: d

Diff: M

Time line: line: ks = 11% 11%

0 gn = -5% -5% | 2.00

P0 =

1 | 1.9 0

$1.90

ˆ

0.11 - (-0.05)

2 | 1.80 5

=

$1.90 0.16

3 | 1.71475

4 Years | 1.6290125

= $11.875. $11.875.

P3 = $11.875( $11.875(0.95 0.95) )3 = $10.18 $10.18. . ˆ

92.

Stock growth rate Requ Requir ired ed rate rate of retur return: n:

Answer: d

Diff: M

ks = 11% 11% + (14% (14% - 11%) 11%)0. 0.5 5 = 12.5 12.5%. %.

Calcul Calculate ate growth growth rate rate using using ks: D0 (1 + g) P0 = ks - g $2(1 + g) $48 = 0.125 - g $6 - $48g = $2 + $2g $50g = $4 g = 0.08 = 8%. Requir Required ed return return equal equals s total total yield yield (Divid (Dividend end yield yield + Capita Capital l gains gains yield yield). ). Divi Divide dend nd yiel yield d = $2.1 $2.16/ 6/$4 $48. 8.00 00 = 4.5% 4.5%; ; Capi Capita tal l gain gains s yiel yield d = g = 8%. 8%.

93.

Stock growth rate

Answer: e

Diff: M

The The requi equire red d rate ate of ret return urn on the the stock tock is 9% + (6%)0. %)0.8 8 = 13.8% 3.8%. . Usin Using g the the cons consta tant nt grow growth th mode model, l, we can can solv solve e for for the the grow growth th rate rate as foll follow ows: s: $2(1  g) $40 $40 = 0.138  g $5.5 $5.52 2 - $40g 40g = $2 + $2g $2g $42g $42g = $3.5 $3.52 2 g = 8.38 8.38%. %.





















94.

Capital gains yield

Answer: c

Step Step 1: 1:

Calc Calcul ula ate ks, the the requ requir ired ed rate rate of retu return rn: : $2 ks = + 6% = 10% + 6% = 16%. $20

Step Step 2: 2:

Calc Calcul ula ate kRF, the risk-f risk-free ree rate: rate: 16% = kRF + (15% - kRF)1.2 16% = kRF - 1.2k 1.2kRF + 18% 0.2kRF = 2% kRF = 10%. 10%.

Step Step 3:

Calc Calcul ulat ate e the the new new stoc stock k pric price e and and capi capita tal l gain gain: : New New ks = 10% 10% + (15 (15% - 10%) 10%)0 0.6 = 13%. 3%. $2 PNew = = $28.57 $28.57. . 0.13 - 0.06 Ther Theref efo ore, re, the perce ercen ntage tage capit apital al gain ain is 43% 43% follows: $28.57 - $20.00 $8.57 = = 0.4285 0.4285  43%. $20.00 $20.00

Diff: M

ˆ

95.

Capital gains yield

calc calcul ulat ated ed

Answer: d

as

Diff: M

Requir Required ed rate rate of return return, , ks = 8% + (15 (15% - 8%)0 8%)0. .6 = 12.2 12.2% %. Calcul Calculate ate divide dividend nd yield yield and and use to calcul calculate ate capita capital l gains gains yield: yield: $2.00 D1 Divide Dividend nd yield yield = = = 0.08 .08 = 8%. $25.00 P0 Capi Capita tal l gain gains s yiel yield d = Tota Total l yiel yield d - Divi Divide dend nd yiel yield d = 12.2 12.2% % - 8% = 4.2% 4.2%. . Alternative method: D1 P0 = ks - g $25 =

$2.00 0.122 - g

$3.0 $3.05 5 - $25g $25g = $2.0 $2.00 0 $25g $25g = $1.0 $1.05 5 g = 0.042 = 4.2%. Sinc Since e the the stoc stock k is grow growin ing g at a cons consta tant nt rate rate, , g = Capi Capita tal l gain gains s yiel yield. d.

96.

Capital gains yield and dividend yield

Answer: e

D Di iff: M

The The capi capita tal l gain gains s yiel yield d is equa equal l to the the long long-r -run un grow growth th rate rate for for this this stoc stock k (since it is a constant growth rate stock) or 7%. To calculate the divide dividend nd yield, yield, first first determ determine ine D1 as $3.42 $3.42  1.0 1.07 7 = $3.6 $3.659 594. 4. The The divi divide dend nd yield yield is $3.659 $3.6594/$ 4/$32. 32.35 35 = 11.31% 11.31%. .























97.

Expected return and P/E ratio Data Data giv given: en: $2.40.

98.

Answer: b

Diff: M

EPS = $2.00; .00; P/E P/E = 40×; 0×; P0 = $80; D1 = $1.0 $1.00; 0; ks = 10%; 10%; EPS EPS1 =

Step Step 1:

Calc Calcul ulat ate e the the pric price e of the the stoc stock k one one year year from from toda today: y: ks = D1/P0 + (P1 - P0)/P0 0.10 0.10 = $1/$ $1/$80 80 + (P1 - $80)/$80 $80)/$80 8 = $1 $1 + P 1 - $80 $87 = P1.

Step Step 2:

Calc Calcul ulat ate e the the P/E P/E rati ratio o one one year year from from toda today: y: P/E P/E = $87/ $87/$2 $2.4 .40 0 = 36.2 36.25× 5×. .

St Stock price and P/E ratio Step Step 1:

Calc Calcul ulat ate e the the requ requir ired ed rate rate of retur return: n: ks = 8% + 2.0(1 .0(12% 2% - 8%) 8%) = 16%. 6%.

Step Step 2:

Calc Calcul ulat ate e the the curr curren ent t mark market et price: price: $1.50(1.10)  $27.50. P0  0.16  0.10

Step Step 3:

Calc Calcul ulat ate e the the earn earnin ings gs and P/E ratio ratio: : D1 = $1.5 $1.50( 0(1. 1.10 10) ) = $1.6 $1.65 5 = 0.30 0.30E E1. E1 = $1.65/ $1.65/0.3 0.30 0 = $5.50. $5.50. $27.50 P0 = = 5.0. $5.50 E1

Answer: a

Diff: M





















99.

Stock price Step Step 1:

Set Set up an inco income me Sales Variable costs Fixed costs EBIT Interest EBT Taxes NI

Answer: d

Diff: M

state stateme ment nt to find find net inco income me: : $100,000 $10  10,000 50,000 $5  10,000 10,000 (Given) $ 40,000 1,200 0.08  $15,000 $ 38,800 15,520 0.40  $38,800 $ 23,280

Then Then, , calc calcul ulat ate e the the tota total l amou amount nt of divi divide dend nds, s, Div Div = Net Net inco income me  Payout Payout = $23,28 $23,280 0  0.6 0.6 = $13,96 $13,968. 8. Dividend Dividends/Sh s/Share are = Total Total dividend dividend/# /# of shares shares outstand outstanding ing = $13,96 $13,968/1 8/10,0 0,000 00 = $1.396 $1.3968. 8. Note Note: : Beca Becaus use e thes these e proj projec ecti tion ons s are are for for the the comi coming ng year year, , this this divi divide dend nd is D1, or the the divi divide dend nd for for the the comi coming ng year year. .

100.

Step Step 2:

Use Use the the CAPM CAPM equa equati tion on to find find the the requ requir ired ed retu return rn on the the stoc stock: k: kS = kRF + (kM - kRF)b = 0.05 0.05 + (0.0 (0.09 9 - 0.05 0.05)1 )1.4 .4 = 0.10 0.106 6 = 10.6 10.6%. %.

Step Step 3:

Calc Calcul ulat ate e stock stock pric price: e: P0 = D1/(kS - g) = $1.39 $1.3968/ 68/(0. (0.106 106 - 0.08) 0.08) = $53.7 $53.72. 2.

Beta coefficient Calcul Calculate ate old requir required ed return return and beta: beta: $2 ks(old) = + 0.05 0.05 = 0.10 0.10. . $40 0.10 = kRF + (RP (RPM)bOld = 0.06 0.06 + (0.0 (0.02) 2)b bOld; bOld = 2.00 2.00. . Calcul Calculate ate new requir required ed return return and beta: beta: $2.00

Answer: c

Diff: M





















101.

Risk and stock value

Answer: d

Diff: M

Calcul Calculate ate requir required ed return return on market market and stock stock: : kM = 0.05 0.05(7 (7%) %) + 0.30 0.30(8 (8%) %) + 0.30 0.30(9 (9%) %) + 0.30 0.30(1 (10% 0%) ) + 0.05 0.05(1 (12% 2%) ) = 9.05 9.05%. %. ks = 6.05 6.05% % + (9.0 (9.05% 5% - 6.05 6.05%) %)2. 2.0 0 = 12.0 12.05% 5%. . Calculat Calculate e expected expected equilibr equilibrium ium stock stock price: price: $2(1.07)  $42.38. P0  0.1205  0.07 ˆ

102.


Answer: b

Diff: M

Firs First, t, find find ks = 6% + 5%(0.8) = 10%. Then, find P0 = D1/(ks - g) g). P0 = $3.0 $3.00/ 0/(0 (0.1 .10 0 – 0.05 0.05) ) = $60. $60. Fina Finall lly, y, comp compou ound nd this this at the the 5% grow growth th rate rate 5 for for 5 year years s to find find P5 . P5 = $60(1.05 $60(1.05) ) = $76.5 $76.58. 8. ˆ

103.

ˆ


Answer: e

Diff: M

The growth growth rate rate is the requi required red return return minus minus the divid dividend end yield yield. . g = 0.1 0.13 - 0.05 0.05 = 0.08 0.08. . What What is D1? 0.05 = D1/$28 D1 = $1.40. $1.40. What What will will be the the Year Year 8 divi divide dend nd? ? D8 = D1  (1 + g)7 = $1.40 $1.40  (1.08)7 = $2.39935 $2.399354. 4. The The Year Year 7 pric price e is give given n by: by: P7 = D8/(ks - g) = $2.3 $2.399 9935 354/ 4/0. 0.05 05 = $47. $47.99 99. . ˆ

104.


Answer: b

Diff: M

Firs First, t, find find D6 = $2.00 $2.00(1. (1.07) 07)5 = $2.8051. Then, calculate ks = 0.06 + 0.05(1 0.05(1.2) .2) = 0.12. 0.12. It foll follow ows s that that: : P5 = $2.805 $2.8051/( 1/(0.1 0.12 2 - 0.07) 0.07) = $56.10 $56.10. .

105


Answer: b

Diff: M





















106.


Answer: b

Step Step 1:

Find Find the the cost cost of equit equity: y: ks = 6% + (12% 12% - 6%)1. %)1.4 4 = 14.4% 4.4%. .

Step Step 2:

Find Find the the valu value e of the the sto stock at the the end of Year ear 1:

Diff: M

P1 = D2/(ks - g) = $1.0 $1.00/ 0/(0 (0.1 .144 44 - 0.05 0.05) ) = $10. $10.63 6383 83. . ˆ

Step Step 3:

Find Find the the valu value e of the the sto stock in Yea Year 4: P4 = P1 (1.05)3 = $10.6383 $10.6383(1.0 (1.05) 5)3 = $12.3152 $12.3152  $12.32. ˆ

107.

ˆ


Answer: b

Step Step 1:

Dete Determ rmin ine e the the stoc stock’ k’s s capi capita tal l gain gains s yiel yield, d, g: ks = D1/P0 + g 14% = 5% + g 9% = g. This This is the stock’ stock’s s growt growth h rate. rate.

Step Step 2:

Calc Calcul ulat ate e the the stoc stock’ k’s s pric price e toda today: y: P0 = D1/(ks - g) = $2.00/ $2.00/(0. (0.14 14 - 0.09) 0.09) = $40. $40.

Step Step 3:

Calc Calcul ulat ate e the the stoc stock’ k’s s pric price e 5 year years s from from today today: : 5 P5 = $40  (1.09) = $61.54 $61.545 5  $61.54.

Diff: M

ˆ

If the stock price today is $40 and the capital gains yield is 9 perc ercent, ent, the stoc stock k pric price e must must grow row by 9 perc percen ent t per per year ear for for the next ext five five years years, , becaus because e this this stock stock is a consta constant nt growth growth stock stock. .

108.

Fu Future stock price--constant growth Step Step 1:

Calc Calcul ulat ate e the the firm firm’s ’s cost cost of equit equity: y: ks = kRF + (RPM)b = 4% + (5%) (5%)1. 1.2 2 10%. 10%.

Answer: e

Di Diff: M

N





















109.

FCF model for valuing stock Step Step 1:

Answer: a

Diff: M

Calc Calcul ulat ate e the the free free cash cash flow flow amoun amount: t: Net   operating Capital    working  FCF1 = EBI EBIT( T(1 1 - T) + Depr Deprec ecia iati tion on Expenditures    capital  = $400 $400 mill millio ion n + $80 $80 mill millio ion n - $160 $160 mill millio ion n - $0 = $320 $320 million. million.

Step 2:

Calculate the firm value corporat corporate e value value model: model: FCF1 Firm Firm va value lue = WACC  g = =

today

using

the

constant

growth

$320 0.10  0.05 $320

0.05 = $6,400 $6,400 milli million. on. This This is the the tota total l firm firm valu value e toda today. y. Step Step 3:

Dete Determ rmin ine e the the mark market et valu value e of the the equi equity ty and and pric price e per per shar share: e: MVTotal = MVEquity + MVDebt $6,400 $6,400 millio million n = MVEquity + $1,400 $1,400 milli million on MVEquity = $5,000 $5,000 milli million. on. This This is toda today’ y’s s mark market et valu value e of the the firm firm’s ’s equi equity ty. . Divi Divide de by the the numb number er of shar shares es to find find the the curr curren ent t pric price e per per shar share. e. $5,000 $5,000 millio million/1 n/125 25 millio million n = $40.0 $40.00. 0.























110.

FCF model for valuing stock

Answer: b

Diff: M

N

Firs First, t, we must must find find the the expe expect cted ed free free cash cash flow flow to be gene genera rate ted d next next year year. . (Remem (Remember ber, , there there was no change change in net net operat operating ing workin working g capita capital.) l.) FCF1 = EBIT( EBIT(1 1 - T) + Deprec Depreciat iation ion – Gross Gross capita capital l expend expenditu itures res FCF1 = $800(1 00(1 - 0.4) + $75 – $255 $255 FCF1 = $300 $300 millio million. n. Now, Now, we can find ind the the value lue of the the enti entire re firm irm since nce there here is a con constan stant t growth growth assumpti assumption. on. Valu Value e of firm firm = FCF FCF1/(WA /(WACC CC – g) Valu Value e of firm firm = $300 $300/( /(0. 0.09 09 - 0.06 0.06) ) Valu Value e of firm firm = $10, $10,00 000 0 mill millio ion. n. Next Next, , we must must find find the the valu value e of the the firm firm’s ’s equi equity ty. . Valu Value e of equi equity ty = Valu Value e of firm firm – Valu Value e of debt debt and and pref prefer erre red d stoc stock k Valu Value e of equi equity ty = $10, $10,00 000 0 – ($90 ($900 0 + $500 $500) ) Value Value of equity equity = $8,600 $8,600 millio million. n. To find find the the valu value e per per shar share e of stoc stock, k, we must must divi divide de the the tota total l valu value e of the the firm’s firm’s equity equity by the number number of share shares s outsta outstandi nding. ng. Valu Value e per per shar share e = Valu Value e of equi equity ty/# /# of shar shares es Value Value per share share = $8,600 $8,600/20 /200 0 Valu Value e per per shar share e = $43. $43.00 00. .





















112.

113.


Answer: e

Diff: M

N

Step Step 1:

Calc Calcul ulat ate e the the firm firm’s ’s free free cash cash flow flows s (in (in mill millio ions ns of doll dollar ars) s) for for the next next year: year: FCF1 = EBIT(1 IT(1 - T) + Dep – Cap Cap Exp. Exp.  NOWC = $300(1 00(1 - 0.4) + $50 – $100 $100 – $60 $60 = $70 $70 millio million. n.

Step Step 2:

Calc Calcul ulat ate e tota total l firm firm value value (TFV) (TFV) today today: : TFV TFV = FCF1/(WA /(WACC CC – g) = $70/ $70/(0 (0.1 .10 0 – 0.06 0.06) ) = $1,750 $1,750 millio million. n.

Step Step 3: 3:

Calc Calcul ulat ate e the the firm firm’s ’s equi equity ty valu value e toda today y by subt subtra ract ctin ing g toda today’ y’s s market market value value of the firm’ firm’s s debt debt and and prefer preferred red stock: stock: MVE = TFV - MVD+P = $1,7 $1,750 50 – $500 $500 = $1,250 $1,250 millio million. n.

Step Step 4:

Calc Calcul ulat ate e the the firm firm’s ’s price price per share share today today: : P0 = MVE/# shares shares = $1,250/2 $1,250/20 0 = $62.50 $62.50. .

New equity and equilibrium price Calcul Calculate ate new equili equilibri brium um price price and determ determine ine change change: :

Answer: c

Diff: M





















115.


Answer: c

Diff: T

Calcul Calculate ate the initia initial l requi required red retur return n and equili equilibri brium um price: price: ks = 0.07 0.07 + (0.0 (0.08) 8)1. 1.5 5 = 0.19 0.19 = 19%. 19%. $2(1.05) D0 (1 + g) P0 = = = $15.00 $15.00. . 0.19 - 0.05 ks - g Calcul Calculate ate the new requir required ed return return and and equili equilibri brium um growth growth rate: rate: New New ks = 0.07 0.07 + (0.0 (0.08) 8)1. 1.75 75 = 0.21 0.21. . $2(1 + g) 0.21 0.21 = + g ; P0 = $15 (Unch (Unchang anged) ed). . $15 $3.1 $3.15 5 - $2.0 2.0 = $2g + $15g 15g $1.1 $1.15 5 = $17g $17g g = 0.06 0.0676 765 5  6.77%.

116.


Answer: c

Time line: line: k = 10% 10%

E0

s 0 1 2 3 gs = 20% 20% gs = 20% gs = 20% 20% gn = 8% | | | | = 2.00 E1 = 2.40 E2 = 2.88 E3 = 3.456

P0 = ?

D1 = 0.48

D2 = 0.576 P3  ˆ

CF

0

0 48

D3 = 0. 0.6912

1.86624 0.10  0.08 0 57 6

= 93.31 93.31 94 003

4 Years | E4 = 3.732 3.73248 48 D4 = 1.866 1.86624 24

Diff: T





















117.

Nonconstant growth stock

Answer: b

Diff: T

Time line: line: k = 12% 12%

s 0 1 g1 = 0% g1 = 0% | | 0.50 0.50

2 g2 = 5% | 0.50

P2 = ? ˆ

P4  ˆ

CFt

0

3 g2 = 5% | 0.525

0.606375 0.12  0.10 0.525

4 gn = 10% 10% | 0.55125

5 Years | 0.606375

= 30.319 30.319 30.87025

Numerical solution: $0.525 $30.87025 P2    $25.08. 2 1.12 (1.12) ˆ

Financia Financial l calculat calculator or solution solution: : Calc Calcul ulat ate e the the PV of the the stoc stock’ k’s s expe expect cted ed cash cash flow flows s as of time time = 2. Inpu Inputs ts: : CF0 = 0 ; C F1 = 0.52 0.525; 5; CF2 = 30.8 30.870 7025 25; ; I = 12. 12. Outp Output ut: : NPV NPV = $25. $25.08 08. . P2 = $25.08 $25.08. . ˆ

118.

Nonconstant growth stock Time line: line: 0 1 g1 = 0% ks = 15% | | P0 = 49.87 D1 = ?

Answer: e

D2

2 g2 = 5% | = D1

D3

3 gn = 10% 4 Year s 10% | | = D2(1.05) D4 = D3(1.10)

Diff: T





















119.


Answer: c

Diff: T

Use Use the the SML SML equa equati tion on to solv solve e for for ks: ks = 0.06 0.0625 25 + (0.0 (0.05) 5)(1 (1.7 .75) 5) = 0.15 0.15 = 15%. 15%. Calculat Calculate e dividend dividend per share: share: D0 = (EPS (EPS0)(Payo )(Payout ut ratio) ratio) = ($2.50 ($2.50)(0 )(0.4) .4) = $1.00. $1.00. Calc Calcul ulat ate e the the divi divide dend nd and and pric price e stre stream am (onc (once e the the stoc stock k beco become mes s a cons consta tant nt growth growth stock): stock): D0 = $1.0 $1.00; 0; D1 = $1.0 $1.00 0  1.25 1.25 = $1.2 $1.25; 5; D2 = $1.2 $1.25 5  1.20 1.20 = $1.5 $1.50; 0; D3 = $1.50 $1.50  1.15 1.15 = $1.7 $1.725 25; ; D4 = $1.725 $1.725  1.07 1.07 = $1.845 $1.84575; 75; $1.725(1.07) P3   $23.071875. 0.15  0.07 ˆ

Put Put all all the the cash cash flow flows s on a time time line line: : Time line: line: 0 k = 15% 1 2 3 15% s | gs = 25% | gs = 20% | gs = 15% | P0

1.00 = ?

1.2500

1.5000

gn = 7%

1.725 0 23.07187 23.071875 5 =

CFt

0

1.2500

1.5000

4 |

Year s

1.84 575 1.84575 0.15  0.07

24 24.796875

Finall Finally, y, use the cash cash flow flow regist register er to calcul calculate ate PV: CF0 = 0; CF1 = 1.25 1.25; ; CF2 = 1.50 1.50; ; CF3 = 24.7 24.796 9687 875; 5; I = 15%; 15%; and and then then solv solve e























120.

Stock growth rate

Answer: b

Diff: T

ks = 10%; P0 = $50; D1 = $1.0 $1.00; 0; g4+ = ? Step Step 1:

Draw Draw the the time time line line: : 0 k = 10% 10% s | g = 25% s

1 2 | g = 25% | g = 25% s s 1.00

1.25

P0 = 50 Step Step 2:

Calc Calcul ulat ate e the the divi divide dend nds: s: g2-4 = 25%. 25%. D1 = $1.00. $1.00.

3 4 | g = 25% | 25% s 1.562 5

gn = ?

1.953125

5 |

Ye ars





















121.

Preferred stock value Time line: line: 0 EAR = 6.183% 1 6.183% | | PV = ?

Answer: d

2 |

Numerical solution: Pp =

$6 0.12

= $50. $50.

Amou Amount nt need needed ed to buy buy 100 100 shar shares es: : $50(10 $50(100) 0) = $5,000 $5,000. . $5,0 $5,000 00 = PV(1 PV(1 + 0.06 0.06/3 /365 65) )5(365) $5,000 $5,000 = PV(1.349 PV(1.3498) 8) PV = $3,704 $3,704.18 .18. .

3 |

4 |

Diff: T

5 Y ears | FV = 5,000





















123.

Stock price--nonconstant growth

Answer: b

Diff: M

N

First, First, we must must find find the explic explicit it foreca forecaste sted d divide dividends nds: : D1 = 0.75 0.75 D2 = 0.9375 (0.75  1.25 1.25 = 0.9375 0.9375) ) D3 = 1.265625 (0.9375  1.35 1.35 = 1.2656 1.265625) 25) D4 = 1.3415625 (1.265625  1.06 1.06 = 1.341 1.341562 5625) 5) Now, Now, we need need to dete determ rmin ine e the the term termin inal al valu value e of the the stoc stock k in Year Year 3, usin using g the Year Year 4 divid dividend end: : P3 = D4/(ks – g) P3 = $1.341 $1.341562 5625/( 5/(0.1 0.10 0 - 0.06) 0.06) P3 = $33.5390 $33.5390625. 625. ˆ

ˆ

ˆ

$

$

($

$





















126.


Answer: b

Diff: M

N

Using the FCF model, P3 = FCF3 (1.07)/(0.11 – 0.07) = [($750 - $500) (1.0 (1.07) 7)]/ ]/0. 0.04 04 = $6,6 $6,687 87.5 .50, 0, whic which h is the the valu value e of the the firm firm at t = 3 afte after r the the dividend dividend is received received. . ˆ

ˆ

So, So, the valu value e of the fir firm today oday = $200/ 200/(1 (1.1 .11 1) + $200/( 00/(1. 1.11 11) )2 + ($250 + $6,687.50)/(1.11)3 = $5,415.1 $5,415.1449 449 million million  $5,415 $5,415 million. million. This This is the the valu value e of the the tota total l firm firm (deb (debt, t, pref prefer erre red d stoc stock, k, and and equi equity ty), ), so the the valu value e of debt ebt and and pref prefer erre red d stoc stock k mus must be dedu deduc cted ted to arri arriv ve at the the valu value e of the the firm firm’s ’s comm common on equi equity ty. . The The comm common on equi equity ty has has a valu value e of $5,4 $5,415 15 mill millio ion n – $700 $700 mil million lion = $4,71 4,715 5 mill illion. ion. So, the pric price/ e/sh sha are = $4,71 4,715 5 million/ million/100 100 million million = $47.15. $47.15.

127.


Answer: b

Diff: M

N

TB_Chapter08 Stocks and Their Valuation

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