Deck 15: Dividend Discount Models

Question 1

The ____ ratio is the portion of earnings not paid out.

A) payout
B) reserve
C) retention
D) debt-to-equity

Answer 1

C

Question 2

A stock has K* = 14%, and you have a K of 8.5%. The stock

A) is overvalued in the market.
B) should not provide your required rate of return.
C) should be purchased.
D) has a NPV less than 0.

Answer 2

should be purchased.

Question 3

The _________ of income method of valuation states that the intrinsic value of any asset is based on the cash flows that the investor expects to receive in the future from owning the asset.

A) capitalization
B) discount rate
C) internal rate of return
D) price to earnings

Answer 3

A

Question 4

Net present value is the ____ value of ____ cash flows expected to be received from a particular investment less the cost of that investment.

A) future, present
B) present, future
C) constant, future
D) risk-adjusted, future

Question 5

The intrinsic value of a common stock is its

A) book value.
B) true value.
C) beta value.
D) alpha value.

Question 6

The DDM valuation models inherently discount all expected dividends

A) until infinity.
B) until the expected stock sale.
C) for 3 years.
D) for 1 year.

Question 7

To calculate the intrinsic value using the constant growth dividend model, you must have

A) g greater than 0.
B) K greater than
C) g less than 0.
D) a market price.
G)

Question 8

In the multiple growth model the dividend growth rate is

A) constant over several time periods.
B) assumed to be changing over several time periods.
C) assumed to grow at the same rate but over different time periods.
D) zero or constant.

Question 9

_____ measures the difference between a stock's implied return and the required return or the degree of mispricing.

A) Delta
B) Beta
C) Alpha
D) The security market line

Question 10

A stock has D0 = $2, and you forecast a constant growth rate of 10%. With a current market price of $30 per share, the IRR is

A) 14.6%.
B) 16.7%.
C) 18.5%.
D) 17.3%.

Question 11

The internal rate of return is sometimes referred to as the _____ return.

A) risk-adjusted
B) implied
C) alpha
D) implicit

Question 12

The measure of correlation between predicted and actual outcomes, indicating the nearness of the points to the line of best fit is referred to as the _____.

A) correlation coefficient
B) beta
C) standard deviation
D) information coefficient

Question 13

The zero-growth, alternatively ____ model, is a type of dividend discount model in which dividends are assumed to maintain a constant value in perpetuity.

A) constant-growth
B) declining-value
C) high-grade
D) no-growth

Question 14

The internal rate of return is the ______ rate that equates the sum of the present value of future cash flows expected to be received from a particular investment to the cost of that investment.

A) prime
B) risk-adjusted
C) discount
D) real

Question 15

The _____ growth model is a type of dividend discount model in which there will be no change in the dividend rate from year to year.

A) constant
B) buy-and-hold
C) risk averse
D) fixed

Question 16

Valuing common stock with a dividend discount model (DDM) requires an estimate of ________ over an infinite time horizon.

A) future earnings
B) current earnings projected
C) future returns
D) future dividends

Question 17

A stock has D0 = $1, and you forecast a constant growth rate of 8%. The current market price is $15, and you require a rate of return of 15%.

A) The IRR is 14.7%.
B) The IRR is less than your required rate of return.
C) The stock is slightly undervalued.
D) You would not buy this stock.

Question 18

A three stage DDM is based on the assumption that companies evolve through _____________ stages during their lifetimes.

A) growth, transition, and maturity
B) growth, maturity, and declining
C) growth, leveling off, and declining
D) steady-state

Question 19

The capitalization model is most accurate in valuing stock that is

A) preferred.
B) constant growth.
C) above-average growth.
D) declining.

Question 20

The valuation model that assumes no future growth of dividends is the

A) capitalization
B) two-stage.
C) internal rate of return.
D) constant growth.

Question 21

Investors prefer the DDM model that best combines realism and ease of calculation. This model is the

A) capitalization.
B) three-stage.
C) constant growth.
D) two-stage.

Question 22

Which of the following does not affect the discount rate in the dividend discount model?

A) risk premium for stocks
B) return on assets
C) real risk free rate
D) expected inflation rate

Question 23

A firm’s earnings per share increased from $5 to $6, its dividends increased from $2 to $2.40, and its share price increased from $80 to $90. Given this information, it follows that

A) the required rate of return decreased
B) the stock experienced a drop in its P/E ratio
C) the firm increased its number of shares outstanding
D) the firm had a decrease in its dividend payout ratio

Question 24

If you purchase an undervalued stock, you would earn the highest rate of return if there is

A) no convergence.
B) complete convergence.
C) negative convergence.
D) partial divergence.

Question 25

A person who forecasts Earnings Per Share can convert to the DDM if he has the firm's

A) payout ratio.
B) forecasted growth rate.
C) Earnings-Price ratio.
D) Price-Earnings ratio.

Question 26

The Graham-Rea model to identifying underpriced common stocks

A) only works for small firms.
B) recommends stocks with high price-earnings ratios.
C) assumes purchases will be held forever.
D) relates stock yields to triple-A bond yields. (e) ignores risk.

Question 27

GE has a return on equity of 20% and a dividend payout ratio of 25%. Its sustainable earnings growth rate is

A) 15%
B) 10%
C) 5%
D) 12%

Question 28

A stock's "normal" Price-Earnings ratio will be higher

A) the larger the required rate of return.
B) the higher the expected growth rate in earnings per share.
C) the greater the expected retention ratio.
D) the smaller the expected payout ratio.

Question 29

Other things being equal, which one of the following would be most consistent with a relatively high growth rate of firm earnings and dividends?

A) the degree of financial leverage is low
B) the inflation rate is low
C) the variability of earnings is low
D) the dividend payout ratio is low

Question 30

The measure of correlation between the predicted and actual rates of return is called the

A) alpha.
B) beta.
C) information coefficient..
D) convergence.

Question 31

During the transition stage, the payout ratio tends to

A) remain stable.
B) be less than during the growth stage.
C) decrease each year.
D) increase each year.

Question 32

The zero growth model assumes a payout ratio of

A) 50%.
B) 0%.
C) 100%.
D) 200%.

Question 33

Assume that at the end of next year, Philip Morris will pay a $2.10 dividend per share. After that, the dividend is expected to increase at a constant rate of 6%. If you require a 12% return of the stock, what is the value of Philip Morris stock?

A) $35.00
B) $28.79
C) $30.83
D) $38.62

Question 34

During the maturity phase, a firm is forecasted to have a payout ratio of 40% and a dividend growth rate of 7%. The implied rate of return on the additional equity investment is

A) 11.7%.
B) 17.5%.
C) 4.2%.
D) 2.8%.

Question 35

The multiple growth DDM model inherently discounts all dividends until

A) infinity.
B) the end of phase 2.
C) the end of phase 3.
D) the stock is sold.

Question 36

A firm has present earnings per share of $4 and forecasts a 15% growth rate. They have a payout ratio of 40%. The average return on equity for new investments is

A) 18%.
B) 40%.
C) 15%.
D) 38%.

Question 37

An analyst typically does not have to supply forecasts for

A) number of years until the transition stage.
B) expected dividends per share.
C) expected earnings per share.
D) payout ratio.

Question 38

For the growth rate in earnings per share to be constant over time,

A) the payout ratio must decrease.
B) the payout ratio must be 100%.
C) the average return on new investments must be constant.
D) the retention ratio must decrease.

Question 39

In the three-stage DDM model, the last stage is

A) transition.
B) stagnation.
C) maturity.
D) decline.

Question 40

In the three-stage DDM model, the lowest payout ratio is during the

A) transition stage.
B) steady state stage.
C) growth stage.
D) maturity stage.

Question 41

You plan to buy some common stock and hold it for one year. You expect to receive both $1.20 in dividends and $62 from the sale of stock at the end of the year. If an investor wants to earn a 13% return, the maximum price you would pay for the stock today is

A) $51.98
B) $54.93
C) $55.93
D) $63.20

Question 42

You assume a future constant growth rate in dividends of 10% and D0 = $2. You require a rate of return of 8%. Using the constant growth rate model, the most you would pay for a share is

A) $ 60.
B) $110.
C) $ 80.
D) $100.

Question 43

In a perfectly efficient market, the information coefficient would be expected to be

A) 0.
B) +.5.
C) +1.
D) -.5.

Question 44

D~=$2.50 and you assume no future growth in dividends. The stock's market price is $25. The stock's K* is

A) 100%.
B) 10%.
C) 2.5%.
D) not enough information.

Question 45

At the beginning of a 5 year transition phase, the dividend growth rate is 24%; at the end at 9%. For year 2 of the transition phase, the expected growth rate used would be

A) 9%.
B) 15%.
C) 18%.
D) 22%.

Question 46

D0=$3 and you assume no future growth in dividends. The current market price is $40, and your required rate of return is 10%. The stock

A) should be purchased for $40.
B) has an intrinsic value of $40.
C) should rise in market price.
D) is overpriced by $10.

Question 47

To purchase a stock, its fairly priced price-earnings ratio should be

A) equal to the actual price-earnings ratio.
B) greater than the actual price-earnings ratio.
C) less than 10.
D) sustained for at least one year.

Question 48

Finding K* or expected rate of return for a stock is similar to the capital budgeting technique of

A) NPV.
B) Payback Period.
C) Profitability Index.
D) IRR.

Question 49

Airbus Industries has a required rate of return of 16%, a constant growth rate of 7%, and a dividend payout ratio of 35%. The stock’s P/E ratio should be

A) 5.5 times
B) 10 times.
C) 8.5 times
D) 10 times,

Question 50

You assume a future, constant growth rate for dividends of 6% and D0 = $1.20. If you require a rate of return of 12%, the intrinsic value is

A) $18.60.
B) $20.
C) $21.20.
D) $11.80.

Question 51

A best fit Security Market Line relating implied returns to Beta is 6% + 8% (Beta). This line implies that for a stock with Beta of 1.5, the riskfree rate is

A) 6%.
B) 12%.
C) 8%.
D) 18%.

Question 52

For a company to maintain a fixed payout ratio into the future, you must assume the dividend growth rate is

A) less than the earnings per share growth rate.
B) lower than the retention rate.
C) higher than the retention rate.
D) the same as the earnings per share growth rate.

Question 53

A company whose stock is selling at a P/E ratio greater than the P/E ratio of the market most likely has

A) greater cyclicality of earnings growth that that of the average company.
B) less predictable earnings growth than that of the average company.
C) an expected earnings growth which is less than that of the average company.
D) a dividend yield which is less than that of the average company.

Question 54

The SML is 7% + 6% (Beta). Your stock has a Beta of .9 and an implied rate of return of 15%. Your stock

A) has a negative rate of return.
B) has a riskfree rate of return of 12.4%.
C) has a positive alpha of 2.6%.
D) has a negative alpha of 2.6%.

Question 55

D0 = $2. You assume a growth rate of 25% for the first two years and a constant 8% thereafter. You require a 14% rate of return. The intrinsic value is

A) $43.22.
B) $54.18.
C) $41.94.
D) $47.88.

Question 56

A firm has D0 = $2, E0 = $5, a forecasted dividend growth rate of 10%, and you require an 18% rate of return. The current stock price is $40. The "normal" price earnings ratio is

A) 9.4.
B) 5.5.
C) 11.2.
D) 8.0.

Question 57

For the multiple growth DDM model, the IRR

A) is less than that of a constant growth model.
B) is always greater than K.
C) can be found directly from annuity tables.
D) is calculated using an educated trial and error method.

Question 58

A stock has a present dividend of $1, and you forecast next year's dividend will be $3. The growth rate is

A) 30%.
B) 100%.
C) 200%.
D) 300%.

Question 59

You forecast a constant dividend growth rate of 8% and D0 = $4. You require a rate of return of 12% and the current market price is $120.

A) The NPV of the stock is -$12.
B) K* is greater than K.
C) The model assumes you will sell the stock within 3 years.
D) The stock is undervalued.

Question 60

D0 = $2 and you assume there will be no future growth in dividends. If your required rate of return is 8%, the most you would pay is

A) $16.
B) $25.
C) $42.
D) $1.60.

Question 61

In the dividend discount model, all of the following factors influence an investor's required rate of return EXCEPT

A) the real risk free rate.
B) the risk premium for stocks.
C) the expected rate of inflation.
D) the return on assets.

Question 62

Which one of the following statements is consistent with a relatively high earnings and dividends growth rate, all other conditions held constant?

A) The firm's financial leverage is low.
B) The dividend payout ratio is low.
C) The rate of inflation is low.
D) The P/E ratio is low.

Question 63

A company has present earnings per share of $4, and you calculate the stock's intrinsic value at $48. The stock's present price-earnings rate is 15.

A) The stock is undervalued in the market.
B) The fairly priced price-earnings rate is too high.
C) The market has a higher required rate of return than your required rate of return.
D) If owned, you should sell the stock.

Question 64

D0 = $1.50. You assume a growth rate of 40% for the first year and a constant 10% thereafter. You require a 15% rate of return and the current price per share is $36. The stock is

A) undervalued by $6.
B) undervalued by $12.
C) overvalued by $6.
D) correctly priced.

Question 65

A firm has D0 = $2.50, E0 = $4, a forecasted dividend growth rate of 8%, and you require a 12% rate of return. The current stock price is $48. The stock

A) is undervalued in the market.
B) should be sold if owned.
C) has a retention ratio of 62.5%.
D) has a payout ratio of 37.5%.

Question 66

A stock sells for $25 with a general forecast of D1 = $1.25. You forecast D1 will be $1.40. If there is complete convergence, your one year rate of return would be

A) 8.5%.
B) 12.4%.
C) 9.1%.
D) 17.6%.

Question 67

The constant-growth dividend discount model will NOT produce a finite value for a stock if the dividend growth rate is

A) above the required rate of return on the stock.
B) above its historical average.
C) below its historical average.
D) below the required rate return on the stock.

Question 68

If GM stock is selling at a P/E ratio greater than the P/E ratio of the market index, the stock has

A) an anticipated earnings growth rate less that the average company.
B) less predictable earnings growth than that of the average company.
C) a dividend yield which is less than that of the average company.
D) greater cyclicality of earnings growth than that of the average company.

Question 69

Using the constant growth model, an increase in the required rate of return from 14 to 18 percent combined with an increase in the growth rate form 8 to 12 percent would cause the stock price to

A) rise less than 4%
B) fall more than 4%
C) rise more than 6%
D) rise more than 8%