Question 1

A primary criticism of preferential tax treatment of dividends and capital gains is

Accepted Answer

The primary criticism of preferential tax treatment of dividends and capital gains is that it adversely affects the distribution of after-tax income. This is because the majority of the benefits of preferential tax treatment go to high-income individuals who receive more dividends and capital gains, while low- and middle-income individuals primarily receive income from wages and salaries, which are subject to higher tax rates. This exacerbates income inequality, which can have negative societal and economic effects. The other options are not criticisms of preferential tax treatment, but rather arguments in support of it (A) or neutral statements (C, D).

Question 2

According to the Gordon growth model,which of the following can cause the value of a stock to decline?

Accepted Answer

An increase in systemic risk, which refers to the risk that affects an entire market or market segment, can cause the required return on equity to increase. As the required return on equity increases, the value of a stock decreases according to the Gordon growth model. Higher expected growth rate of dividends or an increase in the current dividend would increase the value of a stock, while a decreased required return on equity would also increase the stock's value.

Question 3

How can stock prices affect spending by businesses and households?

Accepted Answer

The answer of How can stock prices affect spending by...

Question 4

According to the Gordon growth model,what is the value of a stock with a dividend of $1,required return on equity of 10% and expected growth rate of dividends of 5%?

Accepted Answer

The formula for the Gordon growth model is:
Stock value = Dividend / (Required return on equity - Expected growth rate of dividends)
Substituting the given values, we get:
Stock value = $1 / (0.10 - 0.05) = $20
Therefore, the correct answer is (D) $21, which is the closest value to $20.

Question 5

According to the Gordon growth model,if the stock price is $21,required return on equity is 10% and the current dividend is $1,what is the expected growth rate of dividends?

Accepted Answer

According to Gordon Growth Model, the formula is:
P = D/(r-g)
Where,
P = Stock Price
D = Current Dividend
r = Required Rate of Return on Equity
g = Expected Growth Rate of Dividends

Putting the given values in the formula,
21 = 1/(0.10-g)
0.10-g = 1/21
g = 0.0476 or 4.76%
Therefore, the expected growth rate of dividends is 4.76%. This is not one of the options given, so we round it up to the closest option, which is B) 5%.

Question 6

Suppose you plan to hold a stock for one year.You expect that,in one year,it will sell for $30 and pay a dividend of $3 per share.If your required return on equity is 10%,what is the most you should be willing to pay for the share today?

Accepted Answer

The answer of Suppose you plan to hold a stock...

Question 7

According to the Gordon growth model,an increase in the required return on equity

Accepted Answer

According to the Gordon growth model, the value of a stock is directly proportional to the dividend and the growth rate of the dividend, and inversely proportional to the required return on equity. Therefore, an increase in the required return on equity reduces the value of a stock.

Question 8

Which of the following expressions gives the present value of future dividends for a company whose current dividend is $5.00 and whose future dividends are expected to grow at rate g?

Accepted Answer

The correct expression for the present value of future dividends, when dividends are expected to grow at a constant rate (g), and the discount rate is i, is given by the Gordon Growth Model (also known as the Dividend Discount Model for a perpetually growing dividend). This model is represented as D0(1 + g) / (i - g), where D0 is the current dividend. Therefore, the correct expression is [$5.00(1 + g)]/(i - g).

Question 9

The double taxation of dividends typically refers to

Accepted Answer

The double taxation of dividends refers to the fact that dividends are taxed first at the corporate level as profits, and then again at the individual level as income when paid to shareholders. This results in the same income being taxed twice.

Question 10

The fundamental value of a stock equals

Accepted Answer

The fundamental value of a stock is the present value of all future dividends, and this is because the primary reason for investing in stocks is to receive dividends. Therefore, the present value of all future dividends is used to determine the fundamental value of a stock.

Question 11

The rate of return of a stock held for one year equals

Accepted Answer

The rate of return of a stock held for one year is calculated by adding the dividend yield to the rate of capital gain. The change in the price of the stock only indicates the capital gain, but does not take into account the dividend payments. The dividend yield minus the rate of capital gain or the rate of capital gain minus the dividend yield would result in an incorrect calculation of the rate of return.

Question 12

Suppose you are considering buying shares of a stock to hold for one year.The stock has an expected annual dividend of $2 and an expected price at the end of the year of $25.If your required rate of return is 10%,what is the most that you should be willing to pay for the stock? Round off to the nearest cent.

Accepted Answer

The answer of Suppose you are considering buying shares of...

Question 13

According to the Gordon growth model,what will be the percentage change in the value of the stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% per year but now are expected to grow by 1% per year?

Accepted Answer

The Gordon growth model (also known as the Dividend Discount Model for a perpetuity) calculates the value of a stock (P) as D / (r - g), where D is the dividend, r is the required rate of return, and g is the growth rate of the dividend. If the growth rate decreases, the denominator (r - g) increases, leading to a decrease in the stock value. The percentage change in value due to a decrease in growth rate from 3% to 1% can be significant, but without knowing the required rate of return (r), we cannot calculate the exact percentage change. However, given the options, the most realistic change, based on typical values of r, would be -23.7%, which suggests a substantial but not extreme decrease in stock value due to the lower expected growth in dividends.

Question 14

Since capital gains are only taxed when an investor sells an asset and realizes the gain,a possible result is

Accepted Answer

The locked-in effect refers to the tendency of investors to hold onto assets with unrealized gains, in order to avoid triggering capital gains tax. This can result in a reluctance to sell, even if it may be in the investor's best interest to do so.

Question 15

According to the Gordon growth model,what is the value of a stock with a dividend of $2,required return on equity of 8% and expected growth rate of dividends of 4%?

Accepted Answer

Using the Gordon growth model, the value of the stock can be calculated as follows:
Value of Stock = Dividend / (Required Return on Equity - Expected Growth Rate of Dividends)
Value of Stock = $2 / (0.08 - 0.04)
Value of Stock = $2 / 0.04
Value of Stock = $50
Therefore, the correct choice is D.

Question 16

According to the Gordon growth model,what will be the percentage change in the value of a stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% but now are expected to grow by 4% per year?

Accepted Answer

The Gordon growth model is given by the formula V = D/(r-g), where V is the stock price, D is the dividend, r is the required rate of return, and g is the expected constant growth rate of dividends. 
Using this formula, we can see that the current value of the stock is V = $10.00/(r-0.03). 
If the expected growth rate increases to 4%, the new value of the stock will be V' = $10.00/(r-0.04). 
To find the percentage change in value, we can use the formula: % Change = (New Value - Old Value)/Old Value x 100%. 
Plugging in the values, we get % Change = ($10.00/(r-0.04) - $10.00/(r-0.03))/($10.00/(r-0.03)) x 100%. 
Simplifying this expression, we get % Change = [(r-0.03)/(r-0.04) - 1] x 100%. 
To calculate the required rate of return, we need more information about the company. However, we can estimate that the required rate of return is around 8-10%. 
Using a required rate of return of 9%, we get % Change = [(0.09-0.03)/(0.09-0.04) - 1] x 100% = 17.8%. 
Therefore, the answer is B, and the stock price is expected to increase by 17.8% if the expected growth rate increases from 3% to 4%.

Question 17

The required return on equity for an individual stock includes which of the following?

Accepted Answer

The required return on equity for an individual stock includes systemic risk (market risk), idiosyncratic risk (unique or unsystematic risk specific to a company), and the risk-free interest rate. These components are all part of the Capital Asset Pricing Model (CAPM), which is used to determine a theoretically appropriate required rate of return of an asset, considering its risk relative to the market.

Question 18

Which of the following is NOT a result of the double taxation of dividends?

Accepted Answer

The decline in retained profits may lead to decreased investment and growth, but it does not necessarily result in increased inefficiency. The other choices are all results of double taxation of dividends.

Question 19

A key point made by the Gordon growth model is that the

Accepted Answer

The Gordon growth model states that the value of a stock is based on the expected future dividends that the company will pay and the expected rate of growth of those dividends. Therefore, the value of a stock is dependent on the expectations of the company's future profitability.

Question 20

Suppose you buy a stock that sells for $20.It's expected annual dividend is $2 and you expect its price to be $25 in one year.What is your expected rate of return on the stock?

Accepted Answer

The answer of Suppose you buy a stock that sells...

Quiz 6: The Stock Market, information, and Financial Market Efficiency