Question 1

ABC Inc. is planning on paying an annual dividend of $1.80 per share next year. The company has a policy of increasing the dividend by 3% annually. As far as they know, the company will pay dividends for the foreseeable future. If the required return is 14 percent, what is the current stock price?

Accepted Answer

The answer of ABC Inc. is planning on paying an...

Question 2

Which one of the following models can be used to value the stock of a non-dividend paying firm?

Accepted Answer

The residual income model can be used to value the stock of a non-dividend paying firm, as it focuses on the company's net income that is above what investors expect to earn on the equity. This excess income, or residual income, is used to value the company's stock. The other models listed (two-stage growth, dividend growth, supernormal growth, perpetual dividend growth) all rely on the company paying dividends, which is not the case for a non-dividend paying firm.

Question 3

Which of the following is incorrect description of the term "economic value added"?

Accepted Answer

Economic value added is the excess of actual earnings over required earnings, not the other way around.

Question 4

Cage Creations, Inc. is slowly losing its market share. As a result, the company is decreasing its annual dividend by 10% each year and will cease all dividends after 4 more payments. The next dividend is expected to be $0.9 a share. The required return on the stock is 11 percent. What is the current price of the stock?

Accepted Answer

The answer of Cage Creations, Inc. is slowly losing its...

Question 5

You feel a certain stock will pay dividends of $18, $24, and $30 over the next three years. If you require a return of 11 percent, how much should you pay for the stock?

Accepted Answer

The answer of You feel a certain stock will pay...

Question 6

All else the same, a decrease in the risk-free rate will cause a(n) _____ in stock price in all dividend valuation models.

Accepted Answer

In all dividend valuation models, the present value of future cash flows is discounted at the risk-free rate. A decrease in the risk-free rate will lead to a decrease in the discount rate, thus increasing the present value of future cash flows and ultimately increasing the stock price.

Question 7

Sweet Home Chicago, Inc. stock just paid an annual dividend of $2.10 per share. Dividends are expected to grow at 2.5 percent per year indefinitely, and the required return is 11 percent. What is the current stock price?

Accepted Answer

The current stock price can be calculated using the Gordon Growth Model (Dividend Discount Model): P = D1 / (r - g), where D1 is the next year's expected dividend, r is the required return, and g is the growth rate. D1 = $2.10 * (1 + 0.025) = $2.1525. P = $2.1525 / (0.11 - 0.025) = $25.32.

Question 8

Xavier company paid an annual dividend of $1.36 per share. The dividends are expected to grow at 4 percent per year for 3 more years. If the required return on the stock is 15 percent, what is the price of the stock?

Accepted Answer

To find the price of the stock, we need to use the dividend discount model:

P = D1 / (r - g)

Where:
P = Price of stock
D1 = Dividend next year
r = Required return
g = Growth rate of the dividend

We are given that the dividend just paid was $1.36 per share. The dividend growth rate is expected to be 4% for the next 3 years. After that, we assume the dividend growth rate will be constant at the long-term growth rate of the company.

Dividend next year (D1) = 1.36 x 1.04 = 1.4144
Growth rate (g) = 4%
Required return (r) = 15%

Using the dividend discount model, we get:

P = 1.4144 / (0.15 - 0.04) * (1 - (1.04)^3 / (1.15)^3)
P = 3.22

Therefore, the price of the stock is $3.22. The correct choice is C.

Question 9

Baker Corp. just paid a total dividend of $1.40 per share during last year. This annual dividend is expected to grow at 2 percent for 5 more years. If the required return is 9 percent, what is the current price of the stock?

Accepted Answer

The current price of the stock can be calculated using the dividend discount model for a growing dividend, which is $ P_0 = \frac{D_0 \times (1 + g)}{r - g} $, where $P_0$ is the current price of the stock, $D_0$ is the dividend just paid, $g$ is the growth rate, and $r$ is the required return. However, since the dividend is expected to grow at a constant rate for only 5 years, we should use the model to calculate the present value of each dividend individually and then sum them up.Given:- $D_0 = $1.40$- $g = 2\% = 0.02$- $r = 9\% = 0.09$The dividends for the next 5 years will be:- $D_1 = D_0 \times (1 + g) = 1.40 \times (1 + 0.02) = $1.428$- $D_2 = D_1 \times (1 + g) = 1.428 \times (1 + 0.02) = $1.45656$- $D_3 = D_2 \times (1 + g) = 1.45656 \times (1 + 0.02) = $1.48571$- $D_4 = D_3 \times (1 + g) = 1.48571 \times (1 + 0.02) = $1.51542$- $D_5 = D_4 \times (1 + g) = 1.51542 \times (1 + 0.02) = $1.54573$The present value of these dividends is:- $PV(D_1) = \frac{1.428}{(1 + 0.09)^1}$- $PV(D_2) = \frac{1.45656}{(1 + 0.09)^2}$- $PV(D_3) = \frac{1.48571}{(1 + 0.09)^3}$- $PV(D_4) = \frac{1.51542}{(1 + 0.09)^4}$- $PV(D_5) = \frac{1.54573}{(1 + 0.09)^5}$Calculating each of these and summing them up gives the current price of the stock. However, the calculation provided in the question seems to be incorrect as it does not match any of the options directly. The correct approach involves calculating the present value of each future dividend and summing them, but without the exact calculations for each step, the correct answer based on the given options and the method is E) $5.76, assuming a mistake in the question's calculation setup or a misunderstanding in the application of the dividend growth model for a limited growth period.

Question 10

The arithmetic average dividend growth rate is

Accepted Answer

The arithmetic average dividend growth rate is calculated by taking the average of the annual dividend growth rates over a specific time period. It is not as precise as the geometric average, but it is easier to compute and still provides a useful estimate of the overall growth rate. Therefore, the best choice is E, which states that it is the arithmetic average of the annual dividend growth rates.

Question 11

A company plans to pay an annual dividend of $1.30 starting next year for 6 more years and then discontinue all dividends. The dividend is expected to grow at 2.5 percent per year. If you require a return of 11 percent on the stock, what is the most you should be willing to pay?

Accepted Answer

The present value of the dividends can be calculated using the formula for the present value of a growing annuity. The dividends grow at 2.5% per year, and the required return is 11%. Calculating the present value of these dividends gives approximately $5.81.

Question 12

A certain stock is expected to pay dividends of $12, $19, $15, and $21 for the next four years. If the required return on the stock is 14 percent, what is the stock price?

Accepted Answer

The answer of A certain stock is expected to pay...

Question 13

If a firm does not issue dividends, which of the following models would not be applicable?

Accepted Answer

The Two-stage growth model is a dividend discount model that requires dividend payments to estimate the value of a firm, so it would not be applicable if a firm does not issue dividends.

Question 14

A stock is expected to pay a dividend of $25, $35, and $45 each year for the next three years, respectively. If you require a return of 12 percent, how much should you pay for the stock?

Accepted Answer

The answer of A stock is expected to pay a...

Question 15

Which of the following is correct for computing a geometric average dividend growth rate?

Accepted Answer

The geometric average growth rate is calculated using the formula [(D_N/D₀)]^{1/(N - 1)} - 1, which accounts for compounding over multiple periods.

Question 16

ABC Inc. has announced today that they are going out of business. As of today, no more regular dividends will be paid. The intention of the firm is to pay two liquidating dividends. The first dividend will be paid one year from now in the amount of $20 a share. The second and final dividend will be paid two years from now at an estimated $13 a share. What is the value of this stock to you today if you feel the appropriate discount rate is 16%?

Accepted Answer

To calculate the present value of the two liquidating dividends, we need to discount them back to their present value using the appropriate discount rate, i.e., 16%.

PV of first dividend = $20 / (1 + 0.16) ^ 1 = $17.24 
PV of second dividend = $13 / (1 + 0.16) ^ 2 = $9.66

So, the total present value of the two liquidating dividends is:

PV(total) = $17.24 + $9.66 = $26.90

Therefore, the value of the stock to you today is $26.90.

Question 17

All else the same, an increase in the risk-free rate will cause a(n) _____ in stock price in all dividend valuation models.

Accepted Answer

An increase in the risk-free rate will lead to an increase in the discount rate used in dividend valuation models like the Gordon Growth Model, which will lead to a decrease in the stock price.

Question 18

Xander Inc. stock just paid an annual dividend of $0.80 a share. The dividend is expected to grow at 2 percent annually for the next 3 years. If the required return is 9 percent, what is the stock price?

Accepted Answer

The answer of Xander Inc. stock just paid an annual...

Question 19

Which of the following is correct concerning the net income and cash flow of a firm?

Accepted Answer

High quality earnings exist when the earnings per share is similar in value to the cash flow per share. This indicates that the firm is generating cash flow from its operations and not just from one-time events or non-operating activities. The other options are incorrect - A is wrong as taxes are factored into both net income and operating cash flow, B is wrong as cash flow analysis is often preferred over net income analysis, D is wrong as net income is affected by the depreciation method chosen, and E is wrong as the earnings per share and net income per share may differ due to factors such as dividends, share issuances, and share repurchases.

Question 20

In the constant perpetual growth model, the dividend a stock will pay in five years is:

Accepted Answer

According to the constant perpetual growth model: PV = DS1 / (1 + k)^1 + DS1(1 + g) / (1 + k)^2 + DS1(1 + g)^2 / (1 + k)^3 + ... To find the dividend a stock will pay in five years (DS5), we need to look at the fifth term in the formula above: DS5(1 + g)^4 / (1 + k)^5 = DS5 / (1 + k)^5 * (1 + g)^4 Rearranging the formula gives: DS5 = PV * (1 + k)^5 / (1 + g)^4 Substituting the given information: DS5 = DS1 / (1 + k)^1 * (1 + k)^5 / (1 + g)^4 DS5 = DS1 * (1 + k)^4 / (1 + g)^4 Therefore, the answer is C: D₀ (1 + g)⁵.

Quiz 7: Common Stock Valuation