Question 1

Due to unfavorable economic conditions,EFB Company's earnings and dividends are expected to remain unchanged for the next 3 years.After 3 years,dividends are expected to grow at a 10% annual rate forever.The last dividend was $2,and the required rate of return is 20%.What should be the current market value of EFB stock?

Accepted Answer

Step 1 - Calculate the no growth cash flows and discount them back to today.
PV = 11ea7fdb_fbf6_4ed5_a768_e342d0313edc_TB2902_11 = $1.67
PV = 11ea7fdb_fbf6_4ed6_a768_8b19301d8446_TB2902_11 = $1.39
PV = 11ea7fdb_fbf6_4ed7_a768_87094be8d4cc_TB2902_11 = $1.16
Step 2 - Add these cash flows together.
1.67 + 1.39 + 1.16 = $4.22
Step 3 - Use the Gordon Model to calculate the constant-growth cash flows and discount them back. 11ea7fdb_fbf6_4ed8_a768_1739ba548be5_TB2902_11 = 11ea7fdb_fbf6_4ed9_a768_d70f705a7a54_TB2902_11 11ea7fdb_fbf6_75ea_a768_ab40f1ab27c8_TB2902_11 = 11ea7fdb_fbf6_75eb_a768_c910675c35bc_TB2902_11 = $22
PV = 11ea7fdb_fbf6_75ec_a768_5f9658eba95f_TB2902_11 = $12.73
Step 4 - Add all of the present values together to get the current stock price.
4.22 + 12.73 = $16.95

Question 2

The use of the ________ is especially helpful in valuing firms that are not publicly traded.

Accepted Answer

The industry P/E ratio can be multiplied by the firm's earning to provide a market price. This data can be collected even when shares are not publicly traded or dividends paid.

Question 3

Leonardo's broker called him recently with an offer to buy Downliner Waterproof Furnishings Corp.common stock for $40 per share.His broker promised to repurchase the shares in one year for $45 per share.If Leonardo accepts this deal,what is his required return? The stock is not expected to pay a dividend next year.

Accepted Answer

Return = 11ea7fdb_fbf7_8775_a768_f12796dc4c44_TB2902_11 Return = 11ea7fdb_fbf7_8776_a768_cd8dbbd86e45_TB2902_11 = 12.5%

Question 4

A firm has just paid an annual dividend of $3.00 per share of common stock.If the expected long-run growth rate for this firm is 10%,and if you require an annual rate of return of 16%,how much should you be willing to pay for a share of this stock?

Accepted Answer

Step 1 - Calculate the next dividend payment.
3 × (1.10) = $3.30
Step 2 - Plug the next dividend payment into the Gordon Model. 11ea7fdb_fbf7_123a_a768_e9834af84055_TB2902_11 = 11ea7fdb_fbf7_123b_a768_278c8fe23bdf_TB2902_11 11ea7fdb_fbf7_123c_a768_7f94c2db0fcd_TB2902_11 = 11ea7fdb_fbf7_123d_a768_d30b9ebd5b75_TB2902_11 = $55

Question 5

Dividends are usually paid:

Accepted Answer

Dividends are usually paid quarterly unless otherwise specified.

Question 6

The Textbook Production Company has been hit hard due to increased competition.The company's analysts predict that earnings (and dividends)will decline at a rate of 5% annually forever.Assume that Ks = 11% and Do = $2.00.What will the price of the company's stock be three years from now?

Accepted Answer

11ea7fdb_fbf5_8b74_a768_03a59f182797_TB2902_11 = 11ea7fdb_fbf5_8b75_a768_356d35020088_TB2902_11 11ea7fdb_fbf5_8b76_a768_2303f6128c40_TB2902_11 = 11ea7fdb_fbf5_b287_a768_67bc5c4c647c_TB2902_11 = $10.18

Question 7

The price/earnings ratio:

Accepted Answer

The P/E ratio is calculated by dividing a stock's price by its earnings per share.

Question 8

If the model below is to give a "reasonable" valuation of a stock,which of the following is NOT a valid assumption of the model?
Po = [Do(1 + g)] / (Ke - g)

Accepted Answer

The Gordon Model assumes the growth rate is less than the required return.

Question 9

Assuming g will stay constant,the dividend yield is a good measure of the required return on a common stock under which of the following circumstances?

Accepted Answer

When growth is zero, the dividend yield is a good measure of the required return on common stock.

Question 10

________ is a guide to the firm's value if it is assumed that investors value the earnings of a given firm in the same way they do the average firm in the industry.

Accepted Answer

The P/E multiple provides an easy benchmark for comparison against other firms in an industry.

Question 11

If the average PE ratio for the construction industry is 15 and earnings per share for Lincoln Builders is $2.35,what is the current price of Lincoln's stock?

Accepted Answer

Price = P/E Ratio × EPSPrice = 15 × 2.35 = $35.25

Question 12

The last dividend of SPirex Corporation's common stock was $4.00,and the expected growth is 10 percent.If you require a rate of return of 20%,what is the highest price you should be willing to pay for this stock?

Accepted Answer

Step 1 - Calculate the next dividend payment.
4 × (1.10) = $4.40
Step 2 - Plug the next dividend payment into the Gordon Model. 11ea7fdb_fbf6_eb26_a768_47614c1bb500_TB2902_11 = 11ea7fdb_fbf6_eb27_a768_41e8ae26e01f_TB2902_11 11ea7fdb_fbf6_eb28_a768_15332ff2ffc9_TB2902_11 = 11ea7fdb_fbf6_eb29_a768_d5a3c24bd1b4_TB2902_11 = $44

Question 13

Economically rational buyers and sellers use their assessment of an asset's risk and return to determine its value.Relative to this concept,which of the following is true?

Accepted Answer

The value of an asset is the maximum price a buyer would pay for it.

Question 14

A share of common stock has a current price of $82.50 and is expected to grow at a constant rate of 10 percent.If you require a 14% rate of return,what is the current dividend of this stock?

Accepted Answer

Step 1 - Use the Gordon Model to calculate the next dividend payment. 11ea7fdb_fbf5_1636_a768_f5e876c52b64_TB2902_11 = 11ea7fdb_fbf5_1637_a768_5b9a18e2f522_TB2902_11 82.50 = 11ea7fdb_fbf5_1638_a768_f1baa9c376a4_TB2902_11 11ea7fdb_fbf5_1639_a768_5ffc3cc75263_TB2902_11 = $3.30
Step 2 - Discount the next dividend payment back to today to find the current dividend. 11ea7fdb_fbf5_163a_a768_e127a8bf4405_TB2902_11 = $3.00

Question 15

Assume that the stock of Perry Corporation has just paid an annual dividend of $5,and that this dividend is expected to grow for the next 2 years at an annual growth rate of 20%,and then grow indefinitely at an annual growth rate of 10%.If the risk-free rate is 5%,the expected return on the market is 15%,and the firm's beta is 0.80,how much should you be willing to pay for this stock?

Accepted Answer

Step 1 - Calculate the required rate of return using CAPM. k_e = k_F + β(k_M - k_F ) k_e= .05 + .8(.15 - .05) k_e = 13% Step 2 - Calculate the present value of the high-growth cash flows. PV = 11ea7fdb_fbf6_00ae_a768_794436df87b0_TB2902_11 = $5.31 PV = 11ea7fdb_fbf6_00af_a768_6fcc00106142_TB2902_11 = $5.64 Step 3 - Add these cash flows together. 5.31 + 5.64 = $10.95 Step 4 - Calculate the constant-growth cash flows and discount them back to today. 11ea7fdb_fbf6_00b0_a768_b1e5768382b4_TB2902_11 = 11ea7fdb_fbf6_00b1_a768_3197ab294cc7_TB2902_11 11ea7fdb_fbf6_00b2_a768_33d16ae8e7c5_TB2902_11 = 11ea7fdb_fbf6_27c3_a768_0bc2d7c4fa93_TB2902_11 = $264 PV = 11ea7fdb_fbf6_27c4_a768_d9a743bd1bcc_TB2902_11 = $206.75 Step 5 - Add the two discounted totals together to get the stock price today. 10.95 + 206.75 = $217.70

Question 16

Baldwin Corp.just paid a dividend of $2.00.Over the next two years,this dividend is expected to growth by 20% per year.After two years,dividend growth is expected to level off at 10%.If the required rate of return on Baldwin stock is 12%,what should be the price of Baldwin stock today?

Accepted Answer

Step 1 - Calculate the present value of the high-growth cash flows.
PV = 11ea7fdb_fbf7_394e_a768_1ba618e00981_TB2902_11 = $2.14
PV = 11ea7fdb_fbf7_394f_a768_9ffc75227929_TB2902_11 = $2.30
Step 2 - Add these cash flows together.
2.14 + 2.30 + = $4.44
Step 3 - Calculate the constant-growth cash flows and discount them back to today. 11ea7fdb_fbf7_3950_a768_cbac6df0ac80_TB2902_11 = 11ea7fdb_fbf7_6061_a768_69e7484a13ff_TB2902_11 11ea7fdb_fbf7_6062_a768_59d841c5b919_TB2902_11 = 11ea7fdb_fbf7_6063_a768_130912d00a97_TB2902_11 = $158.40
PV = 11ea7fdb_fbf7_6064_a768_b52277a5305c_TB2902_11 = $126.28
Step 4 - Add the two discounted totals together to get the stock price today.
4.44 + 126.28 = $130.72

Question 17

NYC Company has decided to make a major investment.The investment will require a substantial early cash outflow,and inflows will be relatively late.As a result,it is expected that the impact on the firm's earnings for the first 2 years will cause a negative growth of 5% annually.Further,it is anticipated that the firm will then experience 2 years of zero growth,after which it will begin a positive annual sustainable growth of 6%.If the firm's required return is 10% and its last dividend,D(0),was $2 per share,what should be the current price per share?

Accepted Answer

Step 1 - Calculate the present value of the negative-growth cash flows.
PV = 11ea7fdb_fbf5_3d4b_a768_73db7b2f3385_TB2902_11 = $1.73
PV = 11ea7fdb_fbf5_3d4c_a768_85db559f387c_TB2902_11 = $1.49
Step 2 - Calculate the present value of the zero-growth cash flows.
PV = 11ea7fdb_fbf5_3d4d_a768_3f983691f07f_TB2902_11 = $1.36
PV = 11ea7fdb_fbf5_645e_a768_a91c916b6d28_TB2902_11 = $1.23
Step 3 - Calculate the present value of the constant-growth cash flows and discount it back to today. 11ea7fdb_fbf5_645f_a768_ab90cf94d8e6_TB2902_11 = 11ea7fdb_fbf5_6460_a768_33a4e0e10685_TB2902_11 11ea7fdb_fbf5_6461_a768_592b156baad1_TB2902_11 = 11ea7fdb_fbf5_6462_a768_755176160302_TB2902_11 = $47.83
PV = 11ea7fdb_fbf5_6463_a768_0185f2f443af_TB2902_11 = $32.67
Step 4 - Add the present values together to get the current stock price.
1.73 + 1.49 + 1.36 + 1.23 + 32.67 = $38.48

Question 18

Eastern Auto Parts' last dividend was Do = $0.50,and the company expects to experience no growth in the next 2 years.However eastern will grow at an annual rate of 5% in the third and fourth years,and,beginning with the fifth year,it should attain a 10% growth rate which it should sustain thereafter.Eastern has a cost of capital of 12%.What should be the present price per share of Eastern common stock?

Accepted Answer

Step 1 - Calculate the present value over the zero-growth cash flow years.
PV = 11ea7fdb_fbf6_9cfd_a768_e184d543eb40_TB2902_11 = $.45
PV = 11ea7fdb_fbf6_9cfe_a768_c787e871704e_TB2902_11 = $.40
Step 2 - Calculate the present value of the 5% growth years.
PV = 11ea7fdb_fbf6_9cff_a768_05f82b931339_TB2902_11 = $.37
PV = 11ea7fdb_fbf6_9d00_a768_ad3288af3c08_TB2902_11 = $.35
Step 3 - Calculate the price of the stock for the constant-growth years and discount it back to today. 11ea7fdb_fbf6_9d01_a768_af6d6b8de199_TB2902_11 = 11ea7fdb_fbf6_c412_a768_87c72f8e7c15_TB2902_11 11ea7fdb_fbf6_c413_a768_a7a62e2d2dc5_TB2902_11 = 11ea7fdb_fbf6_c414_a768_d3b7bee0f808_TB2902_11 = $30.32
PV = 11ea7fdb_fbf6_c415_a768_394fad742901_TB2902_11 = $19.27
Step 4 - Add all of the present values together to get the stock price today.
.45 + .40 + .37 + .35 + 19.27 = $20.84

Question 19

A share of common stock has an expected long-run constant growth rate of 10 percent and is currently priced at $66 per share.If investors require 15% rate of return,what was the last dividend paid on the stock?

Accepted Answer

Step 1 - Use the Gordon Model to calculate the next dividend payment. 11ea7fdb_fbf5_b288_a768_d53486d9d9c8_TB2902_11 = 11ea7fdb_fbf5_d999_a768_55e116c533bf_TB2902_11 66 = 11ea7fdb_fbf5_d99a_a768_4d2468d33167_TB2902_11 11ea7fdb_fbf5_d99b_a768_236edab71704_TB2902_11 = $3.30
Step 2 - Discount the next dividend payment to find the dividend just paid. 11ea7fdb_fbf5_d99c_a768_d77fb7f436d8_TB2902_11 = 11ea7fdb_fbf5_d99d_a768_f31c4e161c5f_TB2902_11 = $3.00

Question 20

Given the following information,calculate the expected capital gains yield for Chicago Bears Inc.:
Beta = 0.6; Km = 15%; Krf = 8%; D1 = $2.00: Po =$25.00.Assume the stock is in equilibrium and the exhibits constant growth.

Accepted Answer

Step 1 - Calculate the required rate of return using CAPM. k_e = k_F + β(k_M - k_F ) k_e= .08 + .6(.15 - .08) k_e = 12.2% Step 2 - Calculate the dividend yield and subtract from the required return to find the capital gains yield. Dividend Yield = 11ea7fdb_fbf4_ef25_a768_47085a5cddd9_TB2902_11 = 8% 0.122 - 0.08 = 0.042 or 4.2%

Quiz 8: Stock Valuation and Market Efficiency