Deck 4: The Value of Common Stocks

Question 1

The constant dividend growth formula P₀ = Div₁/(r - g)assumes

A)that dividends grow at a constant rate g, forever only.
B)r > g only.
C)that dividends grow at a constant rate g, forever, and r > g only.
D)g is never negative only.

Answer 1

that dividends grow at a constant rate g, forever, and r > g only.

Question 2

The major secondary market for Boeing shares is:

A)London Stock Exchange.
B)New York Stock Exchange.
C)Hang Seng.
D)Tokyo Stock Exchange.

Answer 2

New York Stock Exchange.

Question 3

Deluxe Company expects to pay a dividend of $2 per share at the end of year 1, $3 per share at the end of year 2, and then be sold for $32 per share at the end of year 2. If the required rate of return on the stock is 15 percent, what is the current value of the stock?

A)$28.20
B)$32.17
C)$32.00
D)$29.18

Answer 3

$28.20

Question 4

CK Company stockholders expect to receive a year-end dividend of $5 per share and then immediately sell their shares for $115 dollars per share. If the required rate of return for the stock is 20 percent, what is the current value of the stock?

A)$132
B)$122
C)$100
D)$110

Question 5

The following are auction markets EXCEPT:

A)New York Stock Exchange.
B)London Stock Exchange.
C)Tokyo Stock Exchange.
D)Nasdaq.

Question 6

MJ Co. pays out 60 percent of its earnings as dividends. Its return on equity is 15 percent. What is the stable dividend growth rate for the firm?

A)9 percent
B)5 percent
C)6 percent
D)15 percent

Question 7

The valuation of a common stock today primarily depends on

A)the number of shares outstanding and the number of its shareholders.
B)its expected future dividends and its discount rate.
C)Wall Street analysts.
D)the price to earnings ratio.

Question 8

If a Wall Street Journal quotation for a company has the values Close = 55.14 and Net change = +1.04, then what was the closing price for the stock for the previous trading day?

A)$56.18
B)$54.10
C)$55.66
D)$53.02

Question 9

The dividend yield reported on finance.yahoo.com is calculated as follows:

A)(dividend/year-high stock price).
B)(dividend/year-low stock price).
C)(dividend/closing stock price).
D)(dividends/earnings).

Question 10

World-Tour Co. has just now paid a dividend of $2.83 per share (Div₀); its dividends are expected to grow at a constant rate of 6 percent per year forever. If the required rate of return on the stock is 16 percent, what is the current value of the stock, after paying the dividend?

A)$70
B)$56
C)$30
D)$48

Question 11

The following are foreign companies that are traded on the New York Stock Exchange:

A)Sony, Telefonica Brasil, and Canadian Pacific only.
B)Sony, Telefonica Brasil, Canadian Pacific, Deutsche Bank, China Eastern Airlines, and Tata Motors.
C)Sony, Telefonica Brasil, Canadian Pacific, and General Electric only.
D)all of the given companies.

Question 12

In which of the following exchanges does a computer act as the sole auctioneer?

A)New York Stock Exchange, London Stock Exchange, Tokyo Stock Exchange, and Deutsche Borse
B)New York Stock Exchange, Tokyo Stock Exchange, and Deutsche Borse only
C)New York Stock Exchange, London Stock Exchange, and Tokyo Stock Exchange only
D)London Stock Exchange, Shanghai Stock Exchange, Tokyo Stock Exchange, and Deutsche Borse only

Question 13

One can estimate the dividend growth rate for a stable firm as

A)plow-back rate/the return on equity (ROE).
B)plow-back rate - the return on equity (ROE).
C)plow-back rate + the return on equity (ROE).
D)plow-back rate × the return on equity (ROE).

Question 14

Casino Inc. expects to pay a dividend of $3 per share at the end of year 1 (Div₁)and these dividends are expected to grow at a constant rate of 6 percent per year forever. If the required rate of return on the stock is 18 percent, what is the current value of the stock today?

A)$25
B)$50
C)$100
D)$54

Question 15

Will Co. is expected to pay a dividend of $2 per share at the end of year 1(Div₁), and the dividends are expected to grow at a constant rate of 4 percent forever. If the current price of the stock is $20 per share, calculate the expected return or the cost of equity capital for the firm.

A)10 percent
B)4 percent
C)14 percent
D)20 percent

Question 16

Assume Boeing has about 10.3 billion shares outstanding and the stock price is $37.10. Also, assume the P/E ratio is about 18.3. Calculate the approximate market capitalization for GE.

A)$679 billion
B)$188 billion
C)$382 billion
D)$103 billion

Question 17

The following is an example of a dealer market:

A)New York Stock Exchange
B)London Stock Exchange
C)Tokyo Stock Exchange
D)Nasdaq

Question 18

A Wall Street Journal quotation for a company has the following values: Div: $1.12, PE: 18.3, Close: $37.22. Calculate the approximate dividend payout ratio for the company.

A)18 percent
B)35 percent
C)45 percent
D)55 percent

Question 19

One can estimate the expected rate of return or the cost of equity capital as follows:

A)Dividend yield - expected rate of growth in dividends.
B)Dividend yield + expected rate of growth in dividends.
C)Dividend yield/expected rate of growth in dividends.
D)(Dividend yield)× (expected rate of growth in dividends).

Question 20

Super Computer Company's stock is selling for $100 per share today. It is expected that-at the end of one year-it will pay a dividend of $6 per share and then be sold for $114 per share. Calculate the expected rate of return for the shareholders.

A)20 percent
B)15 percent
C)10 percent
D)25 percent

Question 21

Seven-Seas Co. just paid a dividend of $3 per share out of earnings of $5 per share. If its book value per share is $40.00 and its market price is $52.50 per share, calculate the required rate of return on the stock.

A)12 percent
B)11 percent
C)5 percent
D)6 percent

Question 22

Summer Co. expects to pay a dividend of $4.00 per share-one year from now-out of earnings of $7.50 per share. If the required rate of return on the stock is 15 percent and its dividends are growing at a constant rate of 10 percent per year, calculate the present value of growth opportunities for the stock (PVGO).

A)$80
B)$30
C)$50
D)$26

Question 23

A company forecasts growth of 6 percent for the next five years and 3 percent thereafter. Given last year's free cash flow was $100, what is its horizon value (PV looking forward from year 4)if the company cost of capital is 8 percent?

A)$0
B)$1,672
C)$2,000
D)$2,676

Question 24

Michigan Co. just paid a dividend of $2 per share. Analysts expect future dividends to grow at 20 percent per year for the next four years and then grow at 6 percent per year thereafter. Calculate the expected dividend in year 5.

A)$4.15
B)$2.95
C)$4.40
D)$3.81

Question 25

Galaxy Air, previously a no-growth firm, has two million shares outstanding. Until now, it consistently earned $20 million per year on its assets. (It has no debt and pays out all earnings as dividends. Its cost of capital is 10 percent.)Due to its newly appointed CEO, Galaxy Air is now able to squeeze out 1 percent annual growth by plowing back 5 percent of earnings. Calculate its stock price per share.

A)$200.00
B)$106.61
C)$100.00
D)$110.10

Question 26

A high proportion of the value of a growth stock typically comes from

A)past dividend payments.
B)past earnings.
C)PVGO (present value of growth opportunities).
D)past dividend payments and past earnings.

Question 27

River Co. just paid a dividend of $2 per share out of earnings of $4 per share. If its book value per share is $25 and its stock is currently selling for $40 per share, calculate the required rate of return on the stock.

A)15.2 percent
B)7.2 percent
C)14.7 percent
D)13.4 percent

Question 28

Analysts often value companies by forecasting a series of cash flows and then estimating a horizon value. Suppose a firm forecasts a project's net cash flows ($millions)in years 1 through 4 as $120, $130, $135, and $137, respectively. If the project ends at the end of the fourth year, what is the horizon value of the project? Assume that the company had a historical growth rate of 3 percent and has a discount rate of 10 percent.

A)$0.00
B)$1.37
C)$1.96
D)$4.87

Question 29

Company X has a P/E ratio of 10 and a stock price of $50 per share. Calculate earnings per share of the company.

A)$6 per share
B)$10 per share
C)$0.20 per share
D)$5 per share

Question 30

The growth rate in dividends is a function of two ratios. They are

A)ROA and ROE.
B)dividend yield and growth rate in stock price.
C)ROE and the plowback ratio.
D)book value per share and EPS.

Question 31

R&D Technology Corporation just paid a dividend of $0.50 per share. Analysts expect its dividend to grow at 24 percent per year for the next two years and then 8 percent per year thereafter. If the required rate of return in the stock is 16 percent, calculate the current value of the stock.

A)$1.11
B)$7.71
C)$8.82
D)$10.38

Question 32

Lake Co. just paid a dividend of $3 per share out of earnings of $5 per share. If its book value per share is $40, what is the expected growth rate in dividends?

A)7.5 percent
B)8 percent
C)12.5 percent
D)5 percent

Question 33

Generally, high growth stocks pay

A)low or no dividends.
B)high, steadily growing dividends.
C)erratic dividends.
D)decreasing dividends.

Question 34

Parcel Corporation expects to pay a dividend of $5 per share next year, and the dividend payout ratio is 50 percent. If dividends are expected to grow at a constant rate of 8 percent forever, and the required rate of return on the stock is 13 percent, calculate the present value of growth opportunities.

A)$100.00
B)$76.92
C)$23.08
D)$69.54

Question 35

Which of the following formulas regarding the earnings-to-price ratio is true?

A)EPS/P₀ = r[1 + PVGO/P₀]
B)EPS/P₀ = r[1 - PVGO/P₀]
C)EPS/P₀ = [r + PVGO/P₀]
D)EPS/P₀ = [1 + r + PVGO/P₀)]/r

Question 36

Which of the following stocks is a growth stock?

A)Dow Chemical
B)Consolidated Edison
C)General Electric
D)Alphabet

Question 37

Universal Air is a no-growth firm and has two million shares outstanding. It expects to earn a constant $20 million per year on its assets. If it has no debt, all earnings are paid out as dividends, and the cost of capital is 10 percent, calculate the current price per share of the stock.

A)$200
B)$150
C)$100
D)$50

Question 38

The In-Tech Co. just paid a dividend of $1 per share. Analysts expect its dividend to grow at 25 percent per year for the next three years and then 5 percent per year thereafter. If the required rate of return on the stock is 18 percent, what is the current value of the stock?

A)$12.97
B)$11.93
C)$15.20
D)$15.78

Question 39

Ocean Co. just paid a dividend of $2 per share out of earnings of $4 per share. If the book value per share is $25, what is the expected growth rate in dividends (g)?

A)16 percent
B)12 percent
C)8 percent
D)4 percent

Question 40

Otobai Motor Company just paid a dividend of $1.40. Analysts expect its dividend to grow at a rate of 18 percent for the next three years and then a constant rate of 5 percent thereafter. What is the expected dividend per share at the end of year 5?

A)$2.35
B)$2.54
C)$2.91
D)$1.50

Question 41

A large percentage of the total value of a growth stock comes from the present value of its growth opportunities.

Question 42

The return that is expected by investors from a common stock is also called its market capitalization rate, or cost of equity capital.

Question 43

Explain the term primary market.

Question 44

Ottocell Motor Company just paid a dividend of $1.40. Analysts expect its dividend to grow at a rate of 10 percent next year, 8 percent for the following two years, and then a constant rate of 5 percent thereafter. What is the expected dividend per share at the end of year 5?

A)$2.08
B)$1.98
C)$1.80
D)$0.99

Question 45

Briefly explain the major types of exchanges prevalent in the United States.

Question 46

One can use the discounted cash flow formulas that are used to value common stocks in order to value entire businesses.

Question 47

Briefly explain the term market capitalization rate.

Question 48

The only payoff to the owners of common stocks is in the form of cash dividends.

Question 49

An investor who uses a limit order instructs his brokerage firm to buy a limited quantity of shares at the best available price.

Question 50

All securities in an equivalent risk class are priced to offer the same expected return.

Question 51

Most exchange traded funds are not actively managed.

Question 52

For most firms, market value is usually greater than book value.

Question 53

It is not possible to value a firm that has a supernormal (variable)growth rate for the first few years of its life.

Question 54

Explain the term secondary market.

Question 55

An investor who uses a market order instructs her brokerage firm to buy a given quantity of shares at the best available price.

Question 56

The New York Stock Exchange is the only stock market in the United States.

Question 57

The cost of equity capital equals the dividend yield minus the growth rate in dividends for a constant dividend growth stock.

Question 58

Most of the trading on the NYSE is in ordinary common stocks.

Question 59

The constant growth formula for stock valuation does not work for a firm with a negative growth rate (i.e., a declining growth rate)in its dividend.

Question 60

A stock's price is based on the expected present value, at the market capitalization rate, of all the stock's future earnings.

Question 61

Briefly explain the assumptions associated with the constant dividend growth formula.

Question 62

Briefly explain why Microsoft experienced a significant drop in price when it announced its first-ever regular dividend along with huge profits.

Question 63

Briefly explain how the formulas that are used for valuing common stocks can also be used to value businesses.

Question 64

Discuss the term price-earnings (P/E)ratio.

Question 65

Discuss the general principle at work in valuing a common stock.