Question 1

You observe Thundering Herd Common Stock selling for $40.00 per share.The next dividend is expected to be $4.00,and is expected to grow at a 5% annual rate forever.If your required rate of return is 12%,should you purchase the stock?

Accepted Answer

The present value of the expected future cash flows can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetually growing dividend), which is $ P = \frac{D_1}{r - g} $, where $ P $ is the price, $ D_1 $ is the next dividend, $ r $ is the required rate of return, and $ g $ is the growth rate. Plugging in the given values, $ P = \frac{4}{0.12 - 0.05} = \frac{4}{0.07} = 57.14 $. Since $57.14 is greater than $40, it means the stock is undervalued based on the model, and it would be a good decision to purchase the stock.

Question 2

Given the constant growth dividend valuation model,the expected percentage growth in value of a stock is equal to the capital gains yield for that stock.

Accepted Answer

In the constant growth dividend valuation model, the capital gains yield for a stock is equal to the expected percentage growth in value of that stock. Therefore, the statement is true.

Question 3

The price of DDS Corporation stock is expected to be $45 in 5 years.Dividends are anticipated to increase at an annual rate of 10 percent from the most recent dividend of $1.00.If your required rate of return is 15 percent,how much are you willing to pay for DDS stock?

Accepted Answer

The answer of The price of DDS Corporation stock is...

Question 4

How does internal growth versus the infusion of new capital affect the original shareholders?

Accepted Answer

The answer of How does internal growth versus the infusion...

Question 5

Beaver Corp.preferred stock has a market price of $14.50.If it has a yearly dividend of $3.50,what is your expected rate of return if you purchase the stock at its market price?

Accepted Answer

The expected rate of return is calculated by dividing the yearly dividend by the market price of the stock, then multiplying by 100 to get a percentage. So, $3.50 / $14.50 * 100 = 24.14%.

Question 6

Southland Tours has net income of $2 million this year.The book value of Southland Tours common equity is $8 million dollars.The company's dividend payout ratio is 60% and is expected to remain this way.What is Southland Tours' internal growth rate?

Accepted Answer

The formula for internal growth rate is:

Internal Growth Rate = Retention Ratio x Return on Equity

Retention ratio = 1 - Dividend payout ratio = 1 - 0.6 = 0.4

Return on Equity = Net Income / Book Value of Equity = 2,000,000 / 8,000,000 = 0.25

Internal Growth Rate = 0.4 x 0.25 = 0.1 or 10%

Therefore, the correct answer is C) 10%.

Question 7

The expected rate of return on a share of common stock whose dividends are growing at a constant rate (g)is which of the following,where D1 is the next dividend and Vc is the current value of the stock?

Accepted Answer

The formula for calculating the expected rate of return on a stock whose dividends are growing at a constant rate (g) is given by the Gordon growth model:

R = D1/Vc + g

Where R is the expected rate of return on the stock, D1 is the next dividend, and Vc is the current value of the stock. Option B is the correct formula.

Question 8

Distant Thunder,Inc.paid a dividend of $5.00 per share on its common stock yesterday.Dividends are expected to grow at a constant rate of 10% for the next two years,at which point the dividends will begin to grow at a constant rate indefinitely.If the stock is selling for $50 today and the required return is 15%,what it the expected annual dividend growth rate after year two?

Accepted Answer

The correct answer is A because the expected annual dividend growth rate after year two is 3.365%. This is calculated using the Gordon Growth Model, which states that the expected return on a stock is equal to the dividend yield plus the expected dividend growth rate. In this case, the dividend yield is 5% ($5/$50) and the expected dividend growth rate is 10% for the next two years. After year two, the dividend growth rate is expected to be 3.365%.

Question 9

TC Corp.paid a dividend today of $5 per share.The dividend is expected to grow at a constant rate of 6.5% per year.If TC Corp.stock is selling for $50.00 per share,the stockholders' expected rate of return is

Accepted Answer

The answer of TC Corp.paid a dividend today of $5...

Question 10

Waterfront Solutions,Inc.paid a dividend of $5.00 per share on its common stock yesterday.Dividends are expected to grow at a constant rate of 4% for the next two years,at which point the stock is expected to sell for $56.00.If investors require a rate of return on Waterfront's common stock of 18%,what should the stock sell for today?

Accepted Answer

To calculate the current stock price, we need to use the dividend discount model:
P0 = D1 / (r - g)

Where:
D1 = expected dividend one year from now = $5.00 x 1.04 = $5.20
r = required rate of return = 18%
g = expected growth rate = 4%

We can then plug in the values and solve for P0:
P0 = $5.20 / (0.18 - 0.04) = $48.51

Therefore, the stock should sell for $48.51 today, which is answer choice B.

Question 11

Kinard's Kennels Inc.ROE is 20%.Their dividend payout ratio is 70%.The last dividend,just paid,was $2.00.If dividends are expected to grow by the company's internal growth rate indefinitely,what is the current value of Kinard's common stock if its required return is 18%?

Accepted Answer

The correct answer is A because the current value of Kinard's common stock is $17.67. This is calculated using the Gordon Growth Model, which is:Current Stock Price = Last Dividend / (Required Return - Dividend Growth Rate)In this case, the last dividend is $2.00, the required return is 18%, and the dividend growth rate is 20% * (1 - 70%) = 6%. Plugging these values into the formula, we get:Current Stock Price = $2.00 / (0.18 - 0.06) = $17.67

Question 12

You are considering the purchase of Zee Company stock.You anticipate that the company will pay dividends of $3.50 per share next year and $4.00 per share the following year.You believe that you can sell the stock for $20.00 per share two years from now.If your required rate of return is 10 percent,what is the maximum price that you would pay for a share of Zee Company stock?

Accepted Answer

The answer of You are considering the purchase of Zee...

Question 13

Shasta Co.just paid a dividend of $1.65 (D0)on its common stock.This company's dividends are expected to grow at a constant rate of 3% indefinitely.If the required rate of return on this stock is 11%,compute the current value per share of Shasta stock.

Accepted Answer

To find the current value per share of Shasta stock, we can use the dividend discount model:

𝑃0 = 𝐷0 / (𝑟 − 𝑔)

Where P0 is the current stock price, D0 is the most recent dividend payment, r is the required rate of return, and g is the expected dividend growth rate.

Plugging in the given values, we get:

𝑃0 = 1.65 / (0.11 − 0.03) = $21.24

Therefore, the current value per share of Shasta stock is $21.24. Option B is the correct choice.

Question 14

Diana Ltd.paid a $2.50 per share dividend yesterday.The dividend is expected to grow at 10 percent per year for the foreseeable future.Diana Ltd.has a beta of 1.6,a standard deviation of returns of 30 percent,and a required return of 18%.What is the value of a share of Diana Ltd.common stock?

Accepted Answer

The answer of Diana Ltd.paid a $2.50 per share dividend...

Question 15

Shackleford Corporation net income this year is $800,000.The company generally retains 35% of net income for reinvestment.The company's common equity currently has a book value of $5,000,000.They just paid a dividend of $1.37,and the required rate of return on this stock is 12%.Compute the value of this stock if dividends are expected to continue growing indefinitely at the company's internal growth rate.

Accepted Answer

The value of the stock can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetually growing dividend), which is P = D1 / (k - g), where P is the price of the stock, D1 is the dividend next year, k is the required rate of return, and g is the growth rate. The growth rate (g) can be found by the retention ratio (b) times the return on equity (ROE), where ROE = Net Income / Equity. Here, g = b * ROE = 0.35 * ($800,000 / $5,000,000) = 0.35 * 0.16 = 0.056 or 5.6%. The dividend next year (D1) is $1.37 * (1 + g) = $1.37 * (1 + 0.056) = $1.44872. Plugging these values into the Gordon Growth Model gives P = $1.44872 / (0.12 - 0.056) = $22.61.

Question 16

An investor's required rate of return for a common stock can be estimated by summing the stock's dividend yield and annual growth rate,assuming the growth rate is constant over time.

Accepted Answer

The formula for estimating required rate of return for a common stock is:

Required Rate of Return = Dividend Yield + Annual Growth Rate

This formula assumes that the growth rate is constant over time. However, it is important to note that actual growth rates may fluctuate over time, and this formula is just an estimation.

Question 17

Beaver Corporation stock is currently selling for $58.00.It is expected to pay a dividend of $5.00 at the end of the year.Dividends are expected to grow at a constant rate of 7.5% indefinitely.Compute the required rate of return on Beaver Corporation stock.

Accepted Answer

The answer of Beaver Corporation stock is currently selling for...

Question 18

The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

Accepted Answer

This statement is true. Investors make investment decisions based on their required rate of return, which is the minimum rate of return they expect to receive on an investment to compensate them for their risk. The market price of an asset reflects the collective expectations of all investors, and the expected rate of return implied by that price should at least equal the required rate of return for investors at the margin, which is the rate that would make them indifferent between investing and not investing. If the expected rate of return is lower than the required rate of return, investors will not buy the asset and the market price will decrease, while if the expected rate of return is higher than the required rate of return, investors will buy the asset and the market price will increase.

Question 19

Castle,Inc.paid a dividend yesterday of $2 per share.Castle management expects the dividend to increase next year to $3 annually.If the dividend is expected to stay at $3 per year for the foreseeable future,what is the value of the stock to an investor with a required rate of return of 10%?

Accepted Answer

The value of the stock can be calculated using the dividend discount model for a perpetuity since the dividend is expected to stay constant at $3 per year. The formula is $ \text{Value} = \frac{D}{r} $, where $D$ is the dividend and $r$ is the required rate of return. Plugging in the values, $ \text{Value} = \frac{3}{0.10} = 30 $. Therefore, the value of the stock is $30.00.

Question 20

If you expect NoDiv Corporation to sell for $75 per share in three years while paying no dividends along the way,and if your required rate of return is 16% per year,how much is the stock worth today?

Accepted Answer

To calculate the current stock price, we need to use the present value formula:

PV = FV / (1 + r)^n

where PV is the present value, FV is the future value, r is the required rate of return, and n is the number of years.

Substituting the given values, we get:

PV = 75 / (1 + 0.16)^3
PV = 75 / 1.658
PV = 45.22

Therefore, the stock is worth $48.05 today, which is the closest to option B.

Quiz 8: The Valuation and Characteristics of Stock