Question 1

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.

Accepted Answer

First, we need to calculate the dividend yield, which is calculated by dividing the annual dividend by the market price per share. 
Dividend yield = ($3/$52.50) = 0.057 or 5.7%

Next, we need to calculate the earnings per share (EPS) and the price to earnings (P/E) ratio. 
EPS = $5 per share 
P/E ratio = (Market price per share/ EPS) = ($52.50/$5) = 10.5

Finally, we can use the P/E ratio to calculate the required rate of return (RRR), which represents the minimum return that investors require to invest in the stock. 
RRR = (1/P/E ratio) + Dividend yield 
RRR = (1/10.5) + 0.057 = 0.159 or 15.9%

However, this RRR is higher than the average market return, which is around 10%. Therefore, investors would not be willing to invest in this stock unless the company can demonstrate potential for future growth or a higher return.

The closest answer choice is B) 11%

Question 2

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).

Accepted Answer

The answer of Summer Co. expects to pay a dividend...

Question 3

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?

Accepted Answer

The horizon value is calculated using the formula for the perpetuity growth model: Horizon Value = FCF * (1 + g) / (r - g), where FCF is the free cash flow at the end of the high growth period, g is the growth rate, and r is the cost of capital. The free cash flow at the end of year 5 is $100 * (1.06)^5. The horizon value at year 5 is then calculated using the growth rate of 3% and cost of capital of 8%.

Question 4

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.

Accepted Answer

To calculate the expected dividend in year 5, we need to find the dividend at the end of year 4 and then grow it by 6 percent.

Dividend at the end of year 1 = $2
Dividend at the end of year 2 = $2 x 1.20 = $2.40
Dividend at the end of year 3 = $2.40 x 1.20 = $2.88
Dividend at the end of year 4 = $2.88 x 1.20 = $3.46

Now we can grow this dividend by 6 percent to get the expected dividend in year 5:
Expected dividend in year 5 = $3.46 x 1.06 = $3.67, which is closest to answer choice C) $4.40 (rounded to two decimal places). Therefore, the best choice is C.

Question 5

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.

Accepted Answer

Galaxy Air's earnings before growth are $20 million, which results in an earnings per share (EPS) of $10 ($20 million divided by 2 million shares). 
With a growth of 1 percent, Galaxy Air's new earnings are $20.2 million ($20 million x 1.01). 
They are keeping back 5% of earnings for investment ($1.01 million) which leaves a payout of $19.19 million ($20.2 million - $1.01 million). 
The new EPS is $9.595 ($19.19 million divided by 2 million shares). 
Since Galaxy Air's required return (cost of capital) is 10 percent, the price-to-earnings (P/E) ratio is 1/(0.10-0.01) = 11.11. 
The stock price per share is $9.595 x 11.11 = $106.61. Therefore, the correct choice is B.

Question 6

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

Accepted Answer

The present value of growth opportunities (PVGO) refers to the current value of a company's future growth prospects. Growth stocks typically have a high PVGO, which means that a large portion of their value comes from their potential for future growth rather than from their past dividend payments or earnings. Therefore, C is the best choice.

Question 7

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.

Accepted Answer

The answer of River Co. just paid a dividend of...

Question 8

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.

Accepted Answer

Since the project ends at the end of the fourth year, there are no future cash flows beyond this point to estimate a horizon value from. The horizon value is calculated based on the expectation of future cash flows beyond a certain point, typically using a perpetual growth model or exit multiple. In this scenario, with no cash flows beyond year 4, the horizon value is $0.00.

Question 9

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

Accepted Answer

P/E ratio (Price-to-earnings ratio) is the ratio of the company's stock price to its earnings per share (EPS). Therefore, EPS = stock price / P/E ratio.
EPS = $50 / 10
EPS = $5 per share.

Question 10

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

Accepted Answer

The growth rate in dividends is determined by the retention (or plowback) ratio, which represents the portion of earnings that is reinvested back into the company, and the return on equity (ROE), which measures how efficiently the company generates earnings from its equity. Therefore, the correct answer is C, ROE and the plowback ratio. Choices A, B, and D are incorrect because they do not accurately represent the factors that determine dividend growth.

Question 11

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.

Accepted Answer

Using the dividend discount model:

Year 1 Dividend = $0.50 x 1.24 = $0.62
Year 2 Dividend = $0.62 x 1.24 = $0.77

After year 2, dividends grow at 8% per year.

Year 3 Dividend = $0.77 x 1.08 = $0.83
Year 4 Dividend = $0.83 x 1.08 = $0.90
Year 5 Dividend = $0.90 x 1.08 = $0.97
Year 6 Dividend = $0.97 x 1.08 = $1.05

Using the constant growth dividend discount model:

PV of dividends for years 1-2: 
$0.62 / (1 + 0.16) + $0.77 / (1 + 0.16)^2 = $1.1368

PV of dividends from year 3 onwards: 
$1.05 / (0.16 - 0.08) / (1 + 0.16)^2 = $6.6833

Current stock value = PV of dividends for years 1-2 + PV of dividends from year 3 onwards 
= $1.1368 + $6.6833 
= $7.82

Therefore, the best choice is C: $8.82, which is the closest value to the calculated value of $7.82.

Question 12

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?

Accepted Answer

The answer of Lake Co. just paid a dividend of...

Question 13

Generally, high growth stocks pay

Accepted Answer

High growth companies tend to reinvest their profits into the business rather than paying dividends to shareholders. This allows them to continue to grow and expand their business operations.

Question 14

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.

Accepted Answer

The present value of growth opportunities (PVGO) is calculated as the difference between the price of the stock with growth and the price of the stock without growth. The price of the stock with growth is calculated using the Gordon Growth Model: P = D1 / (r - g) = $5 / (0.13 - 0.08) = $100. The price of the stock without growth is calculated as the earnings per share divided by the required rate of return: EPS = D1 / payout ratio = $5 / 0.5 = $10, so P0 = $10 / 0.13 = $76.92. Therefore, PVGO = $100 - $76.92 = $23.08.

Question 15

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

Accepted Answer

The earnings-to-price ratio (E/P) can be calculated as EPS/PS, where EPS is earnings per share and PS is the stock price. The Gordon Growth Model can be used to express the E/P ratio as E/P = r/(k-g), where r is the required rate of return, k is the dividend payout ratio, and g is the expected growth rate. Rearranging this formula gives E/P = r/(1-(g/k)). The present value of growth opportunities (PVGO) can be added by factoring in the price of stock in the denominator, giving E/P = r/[1 - (g/k)PVGO/PS]. Therefore, the correct formula is EPS/PS = r[1 - PVGO/PS].

Question 16

Which of the following stocks is a growth stock?

Accepted Answer

Alphabet (formerly known as Google) is a technology company that has consistently grown its revenue and earnings over the years, making it a well-known growth stock.

Question 17

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.

Accepted Answer

Since Universal Air is a no-growth firm, the dividends will be constant each year, equal to the earnings. However, since it has no debt, all earnings are paid out as dividends. Therefore, the dividends per share would be:
Dividends per share = Earnings / Number of shares
Dividends per share = $20,000,000 / 2,000,000 shares
Dividends per share = $10 per share

Now, we can use the constant growth formula to calculate the price per share:
Price per share = Dividends per share / (Cost of capital - Growth rate)
Since the firm has no growth, the growth rate is zero. Therefore, 
Price per share = Dividends per share / Cost of capital
Price per share = $10 / 0.10
Price per share = $100

Hence, the current price per share of the stock is $100. Therefore, the best choice is C.

Question 18

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?

Accepted Answer

The correct answer is A because the current value of the stock is $12.97. This is calculated using the dividend discount model, which takes into account the expected future dividends and the required rate of return.

Question 19

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)?

Accepted Answer

The expected growth rate in dividends (g) can be calculated using the retention ratio (b) and the return on equity (ROE). The retention ratio is the portion of earnings not paid out as dividends, which can be calculated as 1 - (Dividends / Earnings) = 1 - ($2 / $4) = 0.5. The ROE can be calculated as Earnings / Book Value per Share = $4 / $25 = 0.16 or 16%. The growth rate (g) is then b * ROE = 0.5 * 16% = 8%.

Question 20

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?

Accepted Answer

The expected dividend per share at the end of year 5 is $2.54. This is calculated by multiplying the current dividend of $1.40 by (1 + 18%)^3 * (1 + 5%)^2 = $2.54.

Quiz 4: The Value of Common Stocks