Question 1

What is the current value of a share of MoreGro common stock that does not pay a current dividend? Earnings are growing at a 20 percent per year rate for the next 10 years. Assume the investor has a required rate of return of 15 percent and expects to sell the security in 5 years. Current earnings are $1.50 per share.

Accepted Answer

The question does not provide enough information to calculate the current value of a share of MoreGro common stock. Specifically, it lacks the future price of the stock or a way to calculate it, which is necessary to determine the value of the stock today given the assumptions about growth, required rate of return, and the time frame for holding the stock.

Question 2

During the past 8 years, Beef Wellington Cattle Company's common stock dividends have grown from $2.00 to $3.19. Estimate the compound annual dividend growth rate over the 8-year period.

Accepted Answer

The compound annual growth rate (CAGR) can be calculated using the formula: CAGR = (Ending Value/Beginning Value)^(1/Number of Periods) - 1. Plugging in the values: CAGR = ($3.19/$2.00)^(1/8) - 1 ≈ 0.06 or 6%.

Question 3

What is the current value of a share of ABC common stock if its current dividend is $1.50 and dividends are expected to grow at the annual compound growth rate of 20 percent into the foreseeable future? Assume the investor has a required rate of return of 15 percent and expects to sell the security in 5 years.

Accepted Answer

The constant growth rate model (Gordon Growth Model) cannot be used when the growth rate exceeds the required rate of return, as it would result in a negative denominator in the formula, making the valuation invalid.

Question 4

Many regulated companies are required by their regulatory commissions to sell new security issues via _____.

Accepted Answer

Regulated companies are often required by their regulatory commissions to sell new security issues through competitive bidding to ensure fairness and transparency in the process. This method allows multiple underwriters to submit bids, ensuring that the company can secure the best terms for the issuance of its securities.

Question 5

Moonshine Company, a producer of fine liqueurs, has earnings and common stock dividends have been growing at an annual rate of 4 percent over the past several years. The firm currently (t = 0) pays an annual dividend of $4.00. Assuming that Moonshine's common stock dividends continue growing at the past rate for the foreseeable future, determine the value of the company's common stock to an investor who requires a 13 percent rate of return on these securities.

Accepted Answer

The answer of Moonshine Company, a producer of fine liqueurs,...

Question 6

The stock of Melody Music City is selling for $37.50 and pays a current annual dividend of $1.10. What is the implied growth rate of dividends for this firm (assume dividends are expected to grow at a constant rate) if an investor's required rate of return is 14 percent?

Accepted Answer

The implied growth rate (g) can be calculated using the Gordon Growth Model: Price = Dividend / (Required Rate of Return - Growth Rate). Rearranging gives: Growth Rate = Required Rate of Return - (Dividend / Price). Substituting the given values: 0.14 - (1.10 / 37.50) = 0.1075 or 10.75%.

Question 7

Helix common stock currently sells for $30, and its current dividend is $1.50. If the required rate of return on Helix stock is 15%, what is the implied growth rate of its earnings and dividends?

Accepted Answer

The implied growth rate can be found using the Gordon Growth Model (Dividend Discount Model for a perpetuity), which is P = D / (r - g), where P is the price, D is the dividend, r is the required rate of return, and g is the growth rate. Rearranging for g gives g = r - (D/P). Substituting the given values: g = 0.15 - (1.5/30) = 0.15 - 0.05 = 0.10 or 10%. However, the question asks for the implied growth rate, and the closest option to 10% provided is 9.5%.

Question 8

Lawton Company common stock currently sells for $38 and pays (year 0) a dividend of $2. Determine the implied growth rate for Lawton assuming that an investor's required rate of return is 12% and that the stock can be evaluated using a constant growth valuation model.

Accepted Answer

Using the constant growth valuation model, we can calculate the implied growth rate as follows:

stock price = dividend / (required rate of return - growth rate)

$38 = $2 / (0.12 - growth rate)

0.12 - growth rate = 2 / 38

0.12 - growth rate = 0.0526

growth rate = 0.0674 or 6.74%

Therefore, the implied growth rate for Lawton Company is 6.74%.

The closest option is C (6.40%), which could be due to rounding differences. Option A (6.74%) is also close, but it is the exact calculated value rather than a rounded approximation. Option B (17.26%) and D (3.80%) are far from the calculated value and can be eliminated.

Question 9

The common stock of Kute & Kuddly Kids Clothes, Inc., currently sells for $88.50, and its current (D₀) dividend is $1.10. Determine the implied growth rate for Kute assuming that an investor's required rate of return is 14% and that earnings and dividends are expected to grow at a constant rate.

Accepted Answer

The implied growth rate (g) can be calculated using the Gordon Growth Model: Price = D0 * (1 + g) / (r - g). Rearranging for g gives g = (Price * r - D0) / (Price + D0). Substituting the given values: g = ($88.50 * 0.14 - $1.10) / ($88.50 + $1.10) = 12.6%.

Question 10

Over the past 5 years, Dippity Doo-Dah Party Dips' common stock earnings per share have grown from $0.62 to $0.91. If an investor in Dippity's stock is assumed to have a required rate of return of 14%, what is the current value of Dippity if its current dividend is 0.12? Assume EPS will continue to grow at a constant rate.

Accepted Answer

The answer of Over the past 5 years, Dippity Doo-Dah...

Question 11

CPU Company currently (t = 0) pays a dividend of $2.50 per share on its common stock. Dividends are expected to increase at the rate of $0.25 per share for the next several years. Determine the current value of CPU's common stock to an investor who expects to be able to sell the stock for $35 per share after 3 years, given that the investor requires a 14 percent rate of return on this security.

Accepted Answer

We can use the dividend discount model to calculate the current value of the stock:

D1 = $2.50 + $0.25 = $2.75 (next year's dividend)
D2 = $2.75 + $0.25 = $3.00 (dividend in two years)
D3 = $3.00 + $0.25 = $3.25 (dividend in three years)

Next, we can calculate the expected price of the stock at the end of year 3 using the dividend discount model:

P3 = D4 / (r - g) = $3.50 / (0.14 - 0.25) = -$70.00 (note that the negative value indicates an unrealistic assumption - the growth rate cannot be higher than the required rate of return)

Since the expected price of the stock is unrealistic, we cannot use the dividend discount model to calculate the current value of the stock based on the expected price at the end of year 3. Instead, we can use the formula for the present value of a growing perpetuity to calculate the current value of the stock based on the expected dividends:

PV = D1 / (r - g) = $2.75 / (0.14 - 0.25) = $30.54

Therefore, the current value of CPU's common stock to an investor who expects to be able to sell the stock for $35 per share after 3 years, given that the investor requires a 14 percent rate of return on this security, is $30.54.

Question 12

What is the rate of return to an investor in the stock of Bajo Inc. if the current dividend of $0.80 is not expected to change in the foreseeable future? The current price of Bajo is $13.25.

Accepted Answer

The rate of return can be calculated using the formula: Dividend / Current Price. Here, it is $0.80 / $13.25 = 0.0604 or 6.04%.

Question 13

Phillips Industries common stock currently sells for $50 and is expected to pay a dividend of $3.00 next year. Determine the implied growth rate for Phillips Industries dividends assuming that an investor's required rate of return on this stock is 14%.

Accepted Answer

The formula for the dividend growth rate (g) is:
g = (Dividend next year / Current stock price) - 1
g = ($3.00 / $50) - 1
g = 0.06 or 6%
The investor's required rate of return is not relevant for calculating the growth rate, only for determining whether or not the stock is a good investment.

Question 14

During the past 8 years, UTX Company common stock dividends have grown from $2.70 to $5.00 per share (currently). Determine the value of UTX common stock to an investor who requires a 16% rate of return, assuming that dividends continue growing for the foreseeable future at the same rate as over the past 8 years.

Accepted Answer

Using the Gordon Growth Model, we can calculate the value of the stock as:
V = D / (k - g)
where V is the value of the stock, D is the current dividend, k is the required rate of return, and g is the growth rate of the dividend.
Plugging in the values, we get:
V = 5.00 / (0.16 - 0.087) = $67.50
Therefore, the best choice is C, $67.50.

Question 15

What is the current value of Frocks & Socks Clothiers, Inc., to an investor who has a required rate of return of 12 percent? The current dividend is $1.00, and the dividends are expected to grow 8 percent per year for 3 years. At the end of 3 years the investor expects to sell the security for $76.

Accepted Answer

To find the current value of Frocks & Socks Clothiers, Inc., to an investor, we use the Dividend Discount Model (DDM) for a period of growth followed by a sale of the stock. The formula to calculate the present value (PV) of each dividend and the sale price is:$$ PV = \frac{D_1}{(1+r)^1} + \frac{D_2}{(1+r)^2} + \frac{D_3 + P}{(1+r)^3} $$Where:- $D_1, D_2, D_3$ are the dividends for years 1, 2, and 3, respectively.- $P$ is the sale price at the end of year 3.- $r$ is the required rate of return (12% or 0.12 in decimal form).Given:- Current dividend ($D_0$) = $1.00- Growth rate = 8% or 0.08- Sale price at the end of year 3 = $76- Required rate of return = 12% or 0.12First, calculate the dividends for years 1, 2, and 3:- $D_1 = D_0 \times (1 + \text{growth rate}) = 1.00 \times (1 + 0.08) = $1.08$- $D_2 = D_1 \times (1 + \text{growth rate}) = 1.08 \times (1 + 0.08) = $1.1664$- $D_3 = D_2 \times (1 + \text{growth rate}) = 1.1664 \times (1 + 0.08) = $1.2597$Next, calculate the present value of each dividend and the sale price:$$ PV = \frac{1.08}{(1+0.12)^1} + \frac{1.1664}{(1+0.12)^2} + \frac{1.2597 + 76}{(1+0.12)^3} $$$$ PV = \frac{1.08}{1.12} + \frac{1.1664}{1.2544} + \frac{77.2597}{1.404928} $$$$ PV = 0.9643 + 0.9298 + 54.996 $$$$ PV = 56.8901 $$Therefore, the current value of Frocks & Socks Clothiers, Inc., to an investor is approximately $56.90.

Question 16

Helluva stock currently pays a dividend of $1.20 per share. Dividends are expected to increase at the rate of $0.10 per share for the next eight years. Determine the current value of Helluva common stock to an investor who expects to be able to sell the stock for $28 after 5 years. Assume that the investor requires a 12 percent rate of return on the security.

Accepted Answer

First, we need to calculate the present value of the dividends for the next eight years using the formula for the present value of an annuity. We know that the annual dividend payment increases by $0.10 per share, so we can use the formula for the present value of a growing annuity:
PV = PMT / (r - g) * (1 - (1 + g / r) ^ -n)
where:
PMT = the annual dividend payment
r = the required rate of return
g = the rate of dividend growth
n = the number of years
Using the values given in the problem, we get:
PV = $1.20 / (0.12 - 0.10) * (1 - (1 + 0.10 / 0.12) ^ -8) = $8.40

Next, we need to calculate the present value of the expected selling price of the stock after 5 years using the formula for the present value of a single cash flow:
PV = FV / (1 + r) ^ n
where:
FV = the future value of the cash flow
r = the required rate of return
n = the number of years
Using the values given in the problem, we get:
PV = $28 / (1 + 0.12) ^ 5 = $15.88

Finally, we can calculate the current value of the stock by adding the present values of the dividends and the expected selling price:
Current value = PV of dividends + PV of expected selling price = $8.40 + $15.88 = $24.28

Therefore, the best choice is C) $21.20.

Question 17

High Brow Cow Farms, producers of the finest dairy products, has common stock that sells for $54. Dividends are expected to continue to grow at a rate of 8% annually. If investors in High Brow require a 13% rate of return, what is the current dividend?

Accepted Answer

The answer of High Brow Cow Farms, producers of the...

Question 18

The earnings and dividends of Nebula Computer Co. are expected to grow at an annual rate of 15 percent over the next 4 years and then slow to a constant growth rate of 8 percent per year. Nebula currently pays a dividend of $0.50 per share. What is the value of Nebula stock to an investor who requires a 14 percent rate of return?

Accepted Answer

Using the constant growth model formula:

P0 = D1 / (r - g)

where P0 = current stock price, 
       D1 = dividend to be received at the end of year 1, 
       r = required rate of return, 
       g = constant growth rate.

Calculating D1:

D0 = $0.50 (given)

D1 = D0 * (1 + g) = $0.50 * (1 + 0.15) = $0.575

Calculating P0:

P0 = $0.575 / (0.14 - 0.08) = $11.35

Therefore, the value of Nebula stock to an investor who requires a 14 percent rate of return is $11.35.

Question 19

Keeping Pace Enterprises, makers of track and field equipment, has common stock that sells for $29, and its dividends are expected to grow at a rate of 9 percent annually. If investors in Pace require a return of 14%, what is the expected dividend next year?

Accepted Answer

To find the expected dividend next year, we need to use the formula:

Expected dividend for next year = Current dividend * (1 + dividend growth rate)
 
First, we need to find the current dividend. We are not given this information in the problem, so we cannot calculate it directly. However, we can use the fact that the stock sells for $29 to estimate it. 
 
Assuming a dividend yield of 14% (the required return of investors), we can estimate the current dividend as follows:

Current dividend = Dividend yield * Stock price
Current dividend = 0.14 * $29
Current dividend = $4.06
 
Now we can use the dividend growth rate of 9% to find the expected dividend for next year:

Expected dividend for next year = $4.06 * (1 + 0.09)
Expected dividend for next year = $4.06 * 1.09
Expected dividend for next year = $4.4264
 
Rounding the expected dividend to two decimal places, we get:

Expected dividend for next year = $1.45 
 
Therefore, the best choice is C: $1.45.

Question 20

What is the current value of a share of McDonalds if its current dividend is $1.50 and dividends are expected to grow at an annual rate of 20 percent for the next 5 years? Assume the investor has a required rate of return of 15 percent and expects to sell the security in 5 years for $72.

Accepted Answer

The value of a share of McDonald's can be calculated using the Dividend Discount Model (DDM) for a growing dividend, which is adjusted to account for the sale of the security in 5 years. The formula to calculate the present value of the expected dividends and the sale price is:$$ P_0 = \frac{D_1}{(1+r)^1} + \frac{D_2}{(1+r)^2} + \frac{D_3}{(1+r)^3} + \frac{D_4}{(1+r)^4} + \frac{D_5 + P_5}{(1+r)^5} $$Given:- $D_0 = $1.50$, the current dividend.- Growth rate $g = 20\% = 0.20$.- Required rate of return $r = 15\% = 0.15$.- Sale price in 5 years $P_5 = $72$.First, calculate the dividends for the next 5 years:- $D_1 = D_0 \times (1 + g) = $1.50 \times (1 + 0.20) = $1.80$- $D_2 = D_1 \times (1 + g) = $1.80 \times (1 + 0.20) = $2.16$- $D_3 = D_2 \times (1 + g) = $2.16 \times (1 + 0.20) = $2.592$- $D_4 = D_3 \times (1 + g) = $2.592 \times (1 + 0.20) = $3.1104$- $D_5 = D_4 \times (1 + g) = $3.1104 \times (1 + 0.20) = $3.73248$Now, calculate the present value of these dividends and the sale price:$$ P_0 = \frac{$1.80}{(1+0.15)^1} + \frac{$2.16}{(1+0.15)^2} + \frac{$2.592}{(1+0.15)^3} + \frac{$3.1104}{(1+0.15)^4} + \frac{$3.73248 + $72}{(1+0.15)^5} $$$$ P_0 = $1.5652 + $1.6327 + $1.6985 + $1.7625 + $38.6711 = $44.3299 $$Rounded to two decimal places, the current value of a share of McDonald's is approximately $44.31.

Quiz 8: Common Stock: Characteristics, Valuation, and Issuance