Question 1

Worldwide Inc.,a large conglomerate,has decided to acquire another firm.Analysts are forecasting a period (2 years)of extraordinary growth (20%),followed by another 2 years of unusual growth (10 %),and finally a normal (sustainable)growth rate of 6% annually.If the last dividend was D(0)= $1.00 per share and the required rate is 8%,what should the market price be today?

Accepted Answer

Step 1 - Calculate the present value of the extraordinary-growth cash flows.
PV = 11ea7fdb_fbf4_52d5_a768_2b9bd9f65f6a_TB2902_11 = $1.11
PV = 11ea7fdb_fbf4_52d6_a768_af1f09b13d2c_TB2902_11 = $1.23
Step 2 - Calculate the present value of the unusual-growth cash flows.
PV = 11ea7fdb_fbf4_52d7_a768_7b27403cc995_TB2902_11 = $1.26
PV = 11ea7fdb_fbf4_52d8_a768_99b384a302f6_TB2902_11 = $1.28
Step 3 - Calculate the value of the constant-growth cash flows and discount it back to today. 11ea7fdb_fbf4_52d9_a768_a599c294b276_TB2902_11 = 11ea7fdb_fbf4_79ea_a768_4b96aafa3912_TB2902_11 11ea7fdb_fbf4_79eb_a768_db01d0ba1f89_TB2902_11 = 11ea7fdb_fbf4_79ec_a768_f96a14426de1_TB2902_11 = $92.35
PV = 11ea7fdb_fbf4_79ed_a768_fdcfea59c9f1_TB2902_11 = $67.88
Step 4 - Add the present values together to get the current stock price.
1.11 + 1.23 + 1.26 + 1.28 + 67.88 = $72.76

Question 2

In 2001,Ryder Corp.paid a dividend of $2.20.In 1995,Ryder paid a dividend of $1.50.What is Ryder's dividend growth rate?

Accepted Answer

g = 11ea7fdb_fbf2_f422_a768_8727adb4cf57_TB2902_11 - 1
g = 11ea7fdb_fbf2_f423_a768_5fbec667ff58_TB2902_11 - 1 = 8%

Question 3

Emmy Lou,Inc.has an expected dividend next year of $5.60 per share,a growth rate of dividends of 10 percent,and a required return of 20 percent.The value of a share of Emmy Lou,Inc.'s common stock is ________.

Accepted Answer

11ea7fdb_fbf3_424c_a768_01beffc14f5b_TB2902_11 = 11ea7fdb_fbf3_695d_a768_cd3f08022005_TB2902_11 11ea7fdb_fbf3_695e_a768_19c4464e0d64_TB2902_11 = 11ea7fdb_fbf3_695f_a768_e16066d2664f_TB2902_11 = $56.00

Question 4

Assume that the average firm in your company's industry is expected to grow at a constant rate of 5%,and its dividend yield is 4%.Your company is about as risky as the average firm in the industry,but it has just developed a line of innovative new products which leads to expect that its earnings and dividends will grow at a rate of 40% this year and 25% the following year,after which growth should match the 5% industry average rate.The last dividend paid was $2.What is the value per share of your firm's stock?

Accepted Answer

Step 1 - Establish the required return for the stock. Industry expected growth rate (5%) + industry dividend yield (4%) = 9%.
Step 2 - Calculate the non-constant growth cash flows.
PV = 11ea7fdb_fbf4_a0fe_a768_c9729db90c7f_TB2902_11 = $2.57
PV = 11ea7fdb_fbf4_a0ff_a768_6793e0bff320_TB2902_11 = $2.95
Step 3 - Calculate the present value of the constant-growth cash flows and discount it back to today. 11ea7fdb_fbf4_a100_a768_09df4b3a4070_TB2902_11 = 11ea7fdb_fbf4_a101_a768_99d8b537df62_TB2902_11 11ea7fdb_fbf4_c812_a768_e1773f85855e_TB2902_11 = 11ea7fdb_fbf4_c813_a768_59c67beb6303_TB2902_11 = $91.88
PV = 11ea7fdb_fbf4_c814_a768_8b9cb4dff88e_TB2902_11 = $77.33
Step 4 - Add the present values together to get the current stock price.
2.57 + 2.95 + 77.33 = $82.85

Question 5

Mammoth Mart's common shares are currently trading for $59.85 and the company paid its annual dividend of $0.60 per share.If your required rate of return is 12%,what is the implied growth rate in dividends? (Assume that dividends are expected to grow at a constant rate in perpetuity.)

Accepted Answer

11ea7fdb_fbf2_09ac_a768_fd2a369eedc2_TB2902_11 = 11ea7fdb_fbf2_09ad_a768_9d6161f64aed_TB2902_11 59.85 = 11ea7fdb_fbf2_09ae_a768_cbb744d13734_TB2902_11 7.182 - 59.85g = .60 + .60g
6.582 = 60.45g
g = 10.89%

Question 6

In the Gordon model,the value of the common stock is the:

Accepted Answer

The Gordon Model is a constant growth model.

Question 7

A common stock currently has a beta of 1.3,the risk-free rate is an annual rate of 6 percent,and the market return is an annual rate of 12 percent.The stock is expected to generate per-share benefits of $5.20 during the coming period.A toxic spill results in a lawsuit and potential fines,and the beta of the stock jumps to 1.6.Assuming zero growth the new equilibrium,price of the stock ________.

Accepted Answer

Step 1 - Use CAPM to calculate the required return. k_e = k_F + β(k_M - k_F ) k_e= .06 + 1.6(.12 - .06) k_e = 15.6% Step 2 - Use the Gordon Model to calculate the price of the stock. 11ea7fdb_fbf2_cd0e_a768_a1b11a5c6691_TB2902_11 = 11ea7fdb_fbf2_cd0f_a768_c51b22269005_TB2902_11 11ea7fdb_fbf2_cd10_a768_25c8e2b155b5_TB2902_11 = 11ea7fdb_fbf2_cd11_a768_753161369ce9_TB2902_11 = $33.33

Question 8

ABC Company has been growing at a 10% rate,and it just paid a dividend of Do= $3.00.Due to a new product,ABC expects to achieve a dramatic increase in its short-run growth rate,to 20% annually for the next 2 years.After this time growth is expected to return to the long-run constant rate of 10%.The company's beta is 2.0,the required return on an average stock is 11%,and the risk free rate is 7%.What should the dividend yield (D1/Po)be today? (Round to the nearest whole percent.)

Accepted Answer

Step 1 - Calculate the required rate of return using CAPM. k_e = k_F + β(k_M - k_F ) k_e= .07 + 2.0(.11 - .07) k_e = 15% Step 2 - Calculate the present value of the high-growth cash flows. PV = 11ea7fdb_fbf3_8f74_a768_0b2377384b66_TB2902_11 = $3.13 PV = 11ea7fdb_fbf3_b685_a768_a72aa15915c3_TB2902_11 = $3.27 Step 3 - Add these cash flows together.3.13 + 3.27 = $6.40 Step 4 - Calculate the constant-growth cash flows and discount them back to today. 11ea7fdb_fbf3_b686_a768_9380077520ec_TB2902_11 = 11ea7fdb_fbf3_b687_a768_93452c10f696_TB2902_11 11ea7fdb_fbf3_b688_a768_c36346bd0873_TB2902_11 = 11ea7fdb_fbf3_b689_a768_bb86b15f0c02_TB2902_11 = $95.04 PV = 11ea7fdb_fbf3_b68a_a768_37c837ab67eb_TB2902_11 = $71.86 Step 5 - Add the two discounted totals together to get the stock price today.6.40 + 71.86 = $78.26 Step 6 - Calculate the dividend yield. Dividend Yield = 11ea7fdb_fbf3_dd9b_a768_6fc4e4d318ec_TB2902_11 = 4.6%

Question 9

Cyberdyne Systems just paid a dividend of $1.32 on its common stock,and the next dividend will be paid one year from now.You require a return of 6%.What is the market price of this stock if dividends are paid annually in perpetuity and grow at the rate of 2.62% per year forever?

Accepted Answer

11ea7fdb_fbf1_9472_a768_192fc74fbcc4_TB2902_11 = 11ea7fdb_fbf1_bb83_a768_ed0cb6f8c8fb_TB2902_11 11ea7fdb_fbf1_bb84_a768_5b00e96d1631_TB2902_11 = 11ea7fdb_fbf1_bb85_a768_114cc9c089dc_TB2902_11 = $40.08

Question 10

Google has just declared a dividend of $2.12 on its common stock.Dividends are paid annually.Dividends are expected to grow at the rapid pace of 10% for the next 4 years,after which growth is expected to slow to 3% per annum forever.During the rapid growth phase,the required return on this investment will be 20%,and it is expected to drop to 12% when growth slows.What is the current market value of this stock?

Accepted Answer

Step 1 - Calculate the present value of the rapid-growth cash flows.
PV = 11ea7fdb_fbf4_04ac_a768_afd9af8e9007_TB2902_11 = $1.94
PV = 11ea7fdb_fbf4_04ad_a768_b3d4d1e475fa_TB2902_11 = $1.78
PV = 11ea7fdb_fbf4_04ae_a768_e3dfd33c8067_TB2902_11 = $1.63
PV = 11ea7fdb_fbf4_04af_a768_a93ee7df481c_TB2902_11 = $1.50
Step 2 - Calculate the value of the stock once the dividends begin growing at a constant rate and discount it back to today. 11ea7fdb_fbf4_04b0_a768_819ea68dcb55_TB2902_11 = 11ea7fdb_fbf4_04b1_a768_c5312a0e17aa_TB2902_11 11ea7fdb_fbf4_2bc2_a768_392d9d7d7221_TB2902_11 = 11ea7fdb_fbf4_2bc3_a768_1d41a4f7d561_TB2902_11 = $35.52
PV = 11ea7fdb_fbf4_2bc4_a768_fb39c2ec3ff1_TB2902_11 = $17.13
Step 3 - Add all of the present values together.
1.94 + 1.78 + 1.63 + 1.50 + 17.13 = $23.98

Question 11

A stock just paid a dividend of $1.15,has a required rate of return of 17%,and a constant dividend growth rate of 3%.What price should this stock be selling for?

Accepted Answer

Step 1 - Calculate the next dividend payment.1.15 × (1.03) = $1.1845
Step 2 - Calculate the price of the stock using the Gordon Model. 11ea7fdb_fbf2_f424_a768_4feed1404570_TB2902_11 = 11ea7fdb_fbf3_1b35_a768_b704a64207c5_TB2902_11 11ea7fdb_fbf3_1b36_a768_ddf2818896f9_TB2902_11 = 11ea7fdb_fbf3_1b37_a768_374963195508_TB2902_11 = $8.46

Question 12

A firm has an expected dividend next year of $1.20 per share,a zero growth rate of dividends,and a required return of 10 percent.The value of a share of the firm's common stock is:

Accepted Answer

11ea7fdb_fbf3_1b38_a768_37a126408cde_TB2902_11 = 11ea7fdb_fbf3_1b39_a768_998f737d3b80_TB2902_11 11ea7fdb_fbf3_424a_a768_2552d5e733bd_TB2902_11 = 11ea7fdb_fbf3_424b_a768_e936373c15e8_TB2902_11 = $12

Question 13

Microsoft Inc.'s dividends are expected to grow at a rate of 1% per year in perpetuity.If the appropriate rate of return on such investments is 11% and the price of a Microsoft share is $20.20,then what is the consensus market estimate of the next dividend? (Assume that next dividend will be paid in one year.)

Accepted Answer

11ea7fdb_fbf2_7ee6_a768_7f0e4cf3145b_TB2902_11 = 11ea7fdb_fbf2_7ee7_a768_af74787f77b1_TB2902_11 20.20 = 11ea7fdb_fbf2_7ee8_a768_e3b980e99667_TB2902_11 11ea7fdb_fbf2_7ee9_a768_b5a0c81cec16_TB2902_11 = $2.02

Question 14

The Blockbuster business model is slowly dying and so Blockbuster's dividends are expected to grow at a rate of -2% per annum in perpetuity.Blockbuster just (yesterday)paid a dividend of $2.00 per share.Blockbuster pays dividends annually.Stock holders require a rate of return of 10%.What is the fair stock price for Blockbuster today?

Accepted Answer

11ea7fdb_fbf2_a5fa_a768_29223f013d68_TB2902_11 = 11ea7fdb_fbf2_a5fb_a768_9303de5e58a1_TB2902_11 11ea7fdb_fbf2_a5fc_a768_c9d866f6c24b_TB2902_11 = 11ea7fdb_fbf2_a5fd_a768_f3a44416756d_TB2902_11 = $16.33

Question 15

A firm has experienced a constant annual rate of dividend growth of 9 percent on its common stock and expects the dividend per share in the coming year to be $2.70.The firm can earn 12 percent on similar risk involvements.The value of the firm's common stock is ________.

Accepted Answer

11ea7fdb_fbf3_6960_a768_ebcdb1575b40_TB2902_11 = 11ea7fdb_fbf3_8f71_a768_43550ebfaf41_TB2902_11 11ea7fdb_fbf3_8f72_a768_0f9a498e8386_TB2902_11 = 11ea7fdb_fbf3_8f73_a768_8bec2bcd9c82_TB2902_11 = $90.00

Question 16

Betty is contemplating purchasing shares in Daily Bugle Corp.and holding them for 2 years,at which time she will sell them.The market price of these shares is expected to be $36.50 in two years (after the second dividend).The next two annual dividends are expected to be: D1=$1.00 and D2=$1.20.The first dividend will be paid on one year and the second in two years.Betty requires a return of 11%.What is the maximum price Betty is willing to pay for shares in this company?

Accepted Answer

Step 1 - Calculate the present value of the dividends.
PV = 11ea7fdb_fbf1_bb86_a768_69def11c2896_TB2902_11 = $.9009
PV = 11ea7fdb_fbf1_e297_a768_cd3bd0a2edcc_TB2902_11 = $.9739
Step 2 - Discount the stock's price in two years back to today.
PV = 11ea7fdb_fbf1_e298_a768_4f513ce816d2_TB2902_11 = $29.62
Step 3 - Add the present values together.
.9009 + .9739 + 29.62 = $31.50

Question 17

The use of which of the following valuation methods,utilized in valuing common stock,is superior since it considers expected earnings?

Accepted Answer

The P/E multiple takes expected earnings into consideration.

Question 18

Royal Bank common shares pay dividends annually.They just paid a $1.50 dividend.Stock holders require a return of 12%.Royal is expected to continue paying dividends that will grow at 3.5% per annum in perpetuity.What is the fair price of a share of Royal Bank stock?

Accepted Answer

11ea7fdb_fbf2_30bf_a768_ed73a5a0baf5_TB2902_11 = 11ea7fdb_fbf2_30c0_a768_75387115ce1a_TB2902_11 11ea7fdb_fbf2_30c1_a768_31b9e3919704_TB2902_11 = 11ea7fdb_fbf2_30c2_a768_cde53e2a5b0d_TB2902_11 = $18.26

Question 19

Tootsie Roll Inc.pays annual dividends that are expected to grow in perpetuity at the rate of 2% per annum.The next dividend is expected to be $1.50 and it will be paid in one year.The price of Tootsie Roll shares is currently $21.43.If you pay that price and hold Tootsie Roll shares,then what return do you expect to earn?

Accepted Answer

11ea7fdb_fbf2_57d3_a768_590c4e09c371_TB2902_11 = 11ea7fdb_fbf2_57d4_a768_01e8d7769e61_TB2902_11 21.43 = 11ea7fdb_fbf2_57d5_a768_bdff29933e91_TB2902_11 21.43k - .4286 = 1.50
21.43k = 1.9286
k = 9%

Question 20

Blockbuster Inc.just paid a dividend of $2 per share.Dividends are expected to grow at a rate of -50% annually over the next three years.After that,it is expected that Blockbuster will cease paying dividends forever.What is the fair market price for a share of Blockbuster if shareholders require a return of 12%?

Accepted Answer

Step 1 - Calculate the present value of the dividends.
PV = 11ea7fdb_fbf1_e299_a768_d5a0f4a50244_TB2902_11 = $.8928
PV = 11ea7fdb_fbf1_e29a_a768_61646ca83807_TB2902_11 = $.3986
PV = 11ea7fdb_fbf2_09ab_a768_6fbf9fb1d898_TB2902_11 = $.1779
Step 2 - Add the present values together.
.8928 + .3986 + .1779 = $1.47

Quiz 8: Stock Valuation and Market Efficiency