Question 1

Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2. What is the return you should require on Torque's stock?

Accepted Answer

5% + 1.2(13% 5%) = 14.6%.

Question 2

An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is

Accepted Answer

$20(1/25) = $0.80.

Question 3

Suppose that the average P/E multiple in the oil industry is 16. Shell Oil is expected to have an EPS of $4.50 in the coming year. The intrinsic value of Shell Oil stock should be

Accepted Answer

16 × $4.50 = $72.00.

Question 4

Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Midwest Airline has a beta of 3.00. The return you should require on the stock is

Accepted Answer

6% + 3(14% 6%) = 30%.

Question 5

An analyst has determined that the intrinsic value of IBM stock is $80 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 22, then it would be reasonable to assume the expected EPS of IBM in the coming year is

Accepted Answer

$80(1/22) = $3.64.

Question 6

Suppose that the average P/E multiple in the oil industry is 22. Exxon is expected to have an EPS of $1.50 in the coming year. The intrinsic value of Exxon stock should be

Accepted Answer

22 × $1.50 = $33.00.

Question 7

High Tech Chip Company is expected to have EPS in the coming year of $2.50. The expected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 70%, the growth rate of dividends should be

Accepted Answer

12.5% × 0.7 = 8.75%.

Question 8

Fools Gold Mining Company is expected to pay a dividend of $8 in the upcoming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Fools Gold Mining Company has a beta of 0.25. The return you should require on the stock is

Accepted Answer

6% + [-0.25(14% 6%)] = 4%.

Question 9

Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is

Accepted Answer

6% + 0.75(14% 6%) = 12%; P = 1.50/(.12 .06) = $25.

Question 10

Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Low Fly Airline has a beta of 3.00. The intrinsic value of the stock is

Accepted Answer

6% + 3(14% 6%) = 30%; P = 7/(.30 .15) = $46.67.

Question 11

High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be

Accepted Answer

g = .125 × .6 = 7.5%; $2.50(1.075) = $2.69.

Question 12

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. The beta of Sure Tool Company's stock is 1.25. If Sure's intrinsic value is $21.00 today, what must be its growth rate?

Accepted Answer

k = .04 + 1.25 (.14 .04); k = .165; .165 = 2/21 + g; g = .07.

Question 13

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25. The market's required rate of return on Sure's stock is

Accepted Answer

4% + 1.25(14% 4%) = 16.5%.

Question 14

An analyst has determined that the intrinsic value of Dell stock is $34 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year will be

Accepted Answer

$34(1/27) = $1.26.

Question 15

A company paid a dividend last year of $1.75. The expected ROE for next year is 14.5%. An appropriate required return on the stock is 10%. If the firm has a plowback ratio of 75%, the dividend in the coming year should be

Accepted Answer

g = .145 × .75 = 10.875%; $1.75(1.10875) = $1.94.

Question 16

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25. What is the intrinsic value of Sure's stock today?

Accepted Answer

k = .04 + 1.25 (.14 .04); k = .165; .165 = (22 P + 2)/P; .165P = 24 - P; 1.165P = 24 ; P = 20.60.

Question 17

Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to have an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be

Accepted Answer

17 × $5.50 = $93.50.

Question 18

Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining Company has a beta of 0.25. The intrinsic value of the stock is

Accepted Answer

k = 6% + [-0.25(14% 6%)] = 4%; P = 8/[.04 (-.02)] = $133.33.

Question 19

Suppose that the average P/E multiple in the oil industry is 20. Dominion Oil is expected to have an EPS of $3.00 in the coming year. The intrinsic value of Dominion Oil stock should be

Accepted Answer

20 × $3.00 = $60.00.

Question 20

Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2. What is the intrinsic value of Torque's stock?

Accepted Answer

k = 5% + 1.2(13% 5%) = 14.6%; P = 1/(.146 .06) = $11.62.

Quiz 18: Equity Valuation Models