Question 1

The growth rate in dividends is a function of two ratios.They are
A)ROA and ROE.
B)dividend yield and growth rate in stock price.
C)ROE and the plowback ratio.
D)book value per share and EPS.

Accepted Answer

The growth rate in dividends depends on the ROE (return on equity), which in turn depends on the plowback ratio (proportion of earnings retained by the company for reinvestment in the business). Therefore, the correct answer is C. The other options are incorrect because they do not directly relate to the growth rate of dividends.

Question 2

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.
A)$0.00
B)$1.37
C)$1.96
D)$4.87

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 3

Generally, high growth stocks pay
A)low or no dividends.
B)high, steadily growing dividends.
C)erratic dividends.
D)decreasing dividends.

Accepted Answer

High growth stocks typically reinvest their earnings into the company rather than paying out dividends. This allows them to fund expansion and increase their growth potential. As a result, high growth stocks generally do not pay high, steadily growing, or even erratic dividends.

Question 4

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)?
A)16 percent
B)12 percent
C)8 percent
D)4 percent

Accepted Answer

We can use the Gordon Growth Model to solve for the expected growth rate in dividends: 
Price = D/(r-g) 
where: 
D = dividend per share 
r = required rate of return 
g = expected growth rate in dividends

We're given D = $2 per share and earnings = $4 per share, so the payout ratio is 50% ($2/$4). This means that the remaining earnings can be reinvested in the company to support future growth.

We're also given the book value per share, which tells us the company's net assets per share. This value is not directly used in the Gordon Growth Model, but it does give us an indication of the company's financial health and growth potential.

Assuming that the required rate of return is 10%, we can solve for g: 
$25 = $2/(0.10 - g) 
$25(0.10 - g) = $2 
$2.50 - $25g = $2 
-$25g = -$0.50 
g = 0.02 or 2%

Therefore, the expected growth rate in dividends is 2%, which corresponds to answer choice C (8% is the growth rate in earnings, not dividends).

Question 5

Which of the following formulas regarding the earnings-to-price ratio is true? A)EPS/P₀ = r[1 + PVGO/P₀] B)EPS/P₀ = r[1 - PVGO/P₀] C)EPS/P₀ = [r + PVGO/P₀] D)EPS/P₀ = [1 + r + PVGO/P₀)]/r

Accepted Answer

The true formula for earnings-to-price ratio is:

EPS/Price = r / (1 - PVGO/Price)

Simplifying this we get:

EPS/Price = r / (Price - PVGO)

Multiplying both numerator and denominator by Price we get:

EPS/Price = r / (Price^2 - PVGO×Price)

Substituting PS for Price and rearranging the terms, we get:

EPS/PS = r / (1 - PVGO/PS)

Hence, the correct option is B.

Question 6

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.
A)$1.11
B)$7.71
C)$8.82
D)$10.38

Accepted Answer

Using the dividend discount model:
D1 = $0.50 x 1.24 = $0.62
D2 = $0.62 x 1.24 = $0.77
For year 3 and beyond, we use the constant growth formula:
D3 = $0.77 x 1.08 = $0.83
Using the formula for the present value of a constant growth stock:
PV = D1 / (r - g) + D2 / (1+r)^2 + D3 / (1+r)^3 + ... + Dn / (1+r)^n
PV = $0.62 / (0.16 - 0.24) + $0.77 / (1+0.16)^2 + ($0.83 / (1+0.16)^3) / (0.16 - 0.08)
PV = $8.82
Therefore, the current value of the stock is $8.82.

Question 7

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?
A)$0
B)$1,672
C)$2,000
D)$2,676

Accepted Answer

The answer of A company forecasts growth of 6 percent...

Question 8

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.
A)$4.15
B)$2.95
C)$4.40
D)$3.81

Accepted Answer

To find the expected dividend in year 5, we will first calculate the dividend for the next four years using the given growth rate of 20% per year:

Year 1 dividend = $2 x 1.2 = $2.40
Year 2 dividend = $2.40 x 1.2 = $2.88
Year 3 dividend = $2.88 x 1.2 = $3.46
Year 4 dividend = $3.46 x 1.2 = $4.15

After the four years, the dividends are expected to grow at a rate of 6% per year. Therefore, the expected dividend in year 5 would be:

Year 5 dividend = $4.15 x 1.06 = $4.38

Therefore, the best choice is C, with an expected dividend of $4.40 which is the closest option.

Question 9

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?
A)$12.97
B)$11.93
C)$15.20
D)$15.78

Accepted Answer

The answer of The In-Tech Co.just paid a dividend of...

Question 10

Company X has a P/E ratio of 10 and a stock price of $50 per share.Calculate earnings per share of the company.
A)$6 per share
B)$10 per share
C)$0.20 per share
D)$5 per share

Accepted Answer

P/E ratio = Price per share / Earnings per share
Therefore, Earnings per share = Price per share / P/E ratio
Earnings per share = $50 / 10 = $5

Question 11

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).
A)$80
B)$30
C)$50
D)$26

Accepted Answer

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

Question 12

A high proportion of the value of a growth stock typically comes from
A)past dividend payments.
B)past earnings.
C)PVGO (present value of growth opportunities).
D)past dividend payments and past earnings.

Accepted Answer

The present value of growth opportunities (PVGO) is the measure of the premium that investors are willing to pay for a stock based on its future growth prospects. Growth stocks are typically companies that are expected to experience above-average growth in earnings and revenue, which investors believe will increase the stock price in the future. Thus, the PVGO accounts for a high proportion of the value of a growth stock. Past dividend payments and earnings may contribute to a stock's value, but they are not the primary drivers of growth stocks.

Question 13

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.
A)$100.00
B)$76.92
C)$23.08
D)$69.54

Accepted Answer

The answer of Parcel Corporation expects to pay a dividend...

Question 14

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.
A)12 percent
B)11 percent
C)5 percent
D)6 percent

Accepted Answer

Dividend payout ratio = Dividend per share / Earnings per share
= 3/5 = 0.6

Retention ratio = 1 - Payout ratio
= 1 - 0.6
= 0.4

ROE = Dividend payout ratio / Retention ratio
= 0.6 / 0.4
= 1.5

Book value per share = $40
Market price per share = $52.50

Required rate of return = (Dividend per share / Market price per share) + ROE
= (3/52.50) + 1.5
= 0.0571 + 1.5
= 1.5571 = 15.57%

Therefore, the required rate of return on the stock is 15.57%, which is closest to option B) 11%.

Question 15

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.
A)$200
B)$150
C)$100
D)$50

Accepted Answer

The operating income of the firm is $20 million, and since it's a no-growth company, all of it is paid out as dividend. Hence, the dividend per share is $10 ($20 million divided by two million shares outstanding). 
Now, using the Gordon Growth Model: 
P0 = D1/(k-g)
Here, 
D1 = $10 (dividend per share) 
k = 10% (the cost of capital) 
g = 0% (since it's a no-growth company, the growth rate is zero) 
Therefore, 
P0 = $10/(0.10-0) = $100 
Hence, the current price per share of the stock is $100.

Question 16

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.
A)15.2 percent
B)7.2 percent
C)14.7 percent
D)13.4 percent

Accepted Answer

The answer of River Co.just paid a dividend of $2...

Question 17

MJ Co.pays out 60 percent of its earnings as dividends.Its return on equity is 15 percent.What is the stable dividend growth rate for the firm?
A)9 percent
B)5 percent
C)6 percent
D)15 percent

Accepted Answer

The stable dividend growth rate for the firm can be calculated using the Gordon growth model, which is:

D1 / (r - g)

where,
D1 = Dividend expected to be paid at the end of the first year
r = Required rate of return
g = Dividend growth rate

D1 can be calculated as:
D1 = Dividend payout ratio * Earnings per share
   = 60% * (Return on equity * Book value of equity per share)
   = 60% * (15% * Book value of equity per share)
   = 9% * Book value of equity per share

Assuming a required rate of return of 15%, the dividend growth rate can be calculated as:
g = D1 / (r - D1)
  = 9% / (15% - 9%)
  = 6%

Therefore, the stable dividend growth rate for the firm is 6% (Choice C).

Question 18

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?
A)7.5 percent
B)8 percent
C)12.5 percent
D)5 percent

Accepted Answer

The answer of Lake Co.just paid a dividend of $3...

Question 19

Which of the following stocks is a growth stock?
A)Dow Chemical
B)Consolidated Edison
C)General Electric
D)Google

Accepted Answer

Google is a technology giant and a leader in the internet search industry, with consistent revenue growth and profitability, making it a prime example of a growth stock. Other options, such as Dow Chemical, Consolidated Edison, and General Electric, are more traditional and established companies in industries with slower growth rates.

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?
A)$2.35
B)$2.54
C)$2.91
D)$1.50

Accepted Answer

We can use the formula for calculating dividends in a growing perpetuity: D1 = D0 (1+g)^n. 
- D0 = $1.40 (the current dividend)
- g1-3 (expected growth rate for first 3 years) = 18%
- g4 onwards (expected constant growth rate after third year) = 5%
- n (number of years) = 5
Calculating the expected dividend per share at the end of year 5: 
D1 = $1.40 (1+0.18)^1 x (1+0.18)^1 x (1+0.18)^1 x (1+0.05)^2 
D1 = $2.54
Therefore, the best choice is B.

Quiz 4: The Value of Common Stocks

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

Generally, high growth stocks pay

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) ?

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

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.

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?

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.

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?

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

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

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.

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.

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.

MJ Co.pays out 60 percent of its earnings as dividends.Its return on equity is 15 percent.What is the stable dividend growth rate for the firm?

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?

Which of the following stocks is a growth stock?

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?