Question 1

The current market value of the 500,000 preferred shares of Clumsy Sports Inc.is $25 million.If the shares pay an annual dividend of $5 on a par value of $85 and the risk-free rate is 5.5 percent,what is the implied risk premium?

Accepted Answer

P=25,000,000/500,000=50
K=D/P=5/50=10%
Implied risk premium=k-RF=10%-5.5%=4.5%

Question 2

The 800,000 preferred shares of Fantastic Services have a market value of $9,192,000 and a book value of $10,000,000.What is the dividend rate if the risk-free rate is 3.15 percent and the risk premium is 3.65 percent?

Accepted Answer

D = [$9,192,000*(3.15%+3.65%)]/$10,000,000 = 6.25%

Question 3

Manic Corporation issued 400,000 preferred shares with a book value of $10 million three years ago.The preferred shares pay an annual dividend of $2.What is the required return if the current market value of these preferred shares is $9.5 million?

Accepted Answer

QUOTE k = 2/(9,500,000/400,000)= 8.42%

Question 4

The Dividend Discount Model (DDM)links common share prices to three important fundamentals: corporate profitability,the general level of interest rates,and risk.All else being equal,the DDM predicts that common share prices will be lower

Accepted Answer

The Dividend Discount Model (DDM) predicts that common share prices will be higher when profits are high, when interest rates are lower, and when risk premiums are lower. Therefore, none of the provided options correctly describe a scenario where share prices would be lower according to the DDM.

Question 5

The current market value of the 500,000 preferred shares of Clumsy Sports Inc.is $25 million.If the shares pay a quarterly dividend of $1.25 on a par value of $85 and the risk premium is 4.5 percent,what is the implied risk-free rate?

Accepted Answer

RF = $5/($25,000,000/500,000)- 4.5% = 5.5%

Question 6

The dividend growth rate for a stable firm can be estimated as:

Accepted Answer

The dividend growth rate for a stable firm can be estimated by multiplying the retention ratio (proportion of earnings retained by the firm for reinvestment) with the return on equity (ROE) which is the rate of return generated on shareholder equity. This is because the retained earnings are reinvested back into the firm, leading to an increase in the equity base and ultimately the dividend payout.

Question 7

Use the following two statements to answer this question:

Accepted Answer

The answer of Use the following two statements to answer...

Question 8

Infinity Inc.has 750,000 preferred shares outstanding,which pay a dividend rate of 5.25 percent.Currently,the market value of these preferred shares is $22.5 million and the short-term government T-bills yield is 5 percent.What is the par value of these shares if investors require a risk premium of 3.75 percent?

Accepted Answer

PV = [($22,500,000/750,000)*(5%+3.75%)]/5.25% =$50

Question 9

Manic Corporation issued 200,000 preferred shares with a book value of $10 million three years ago.If the required return is 8.42% and the current market value of these preferred shares is $9.5 million,what is the annual dividend?

Accepted Answer

(9,500,000*8.42%)/200,000=$4.00

Question 10

How much would you pay for a share of stock today,if you expect it will pay a dividend of $2.50 each year and will sell for $58 one year from now? Assume your required rate of return on this stock is 13 percent.

Accepted Answer

P₀ = ($2.5+$58)/(1+13%)= $53.54

Question 11

Use the following two statements to answer this question:

Accepted Answer

Statement I is incorrect because a firm's sustainable growth rate increases with higher profit margins, higher asset turnover, and higher debt. Statement II is correct because the sustainable growth rate can be estimated by multiplying the earnings retention ratio by the return on equity.

Question 12

How much would you pay for a share of stock today if you expect it will pay a dividend of $2.50 each year and will sell for $58 two years from now? Assume your required rate of return on this stock is 13 percent.

Accepted Answer

P₀ = 2.5/(1+13%)+[(2.5+58)/(1+13%)²]

Question 13

You paid $20 for one share of HyperTension Inc.today.What is the expected one-year holding period return if the stock pays a $1.25 dividend and sells for $21.50 one year from now?

Accepted Answer

K_c = ($1.25+$21.5)/$20 - 1 = 13.75%

Question 14

Which of the following statements is TRUE?

Accepted Answer

Until an investor sells their shares, the only cash flows they will receive are in the form of dividends. However, this statement does not imply that dividends are the only way investors can make money from their investments in the long run. Companies can also increase in value over time, leading to capital gains upon sale of the shares.

Question 15

Which of the following is TRUE about the implicit assumption of the DDM that "investors are rational"?

Accepted Answer

The Dividend Discount Model (DDM) assumes that investors are rational, meaning they value shares based on expected future dividends (I) and do not engage in speculative bubbles, which are contrary to rational valuation (II).

Question 16

The Beautiful Mind Company's preferred stock is selling for $30 per share.What is the expected dividend of year four if the required rate of return is 7.5 percent?

Accepted Answer

D_p = $30*7.5% = $2.25

Question 17

Which of the following is not a correct statement of the Constant Growth DDM?

Accepted Answer

The correct inequality is kS1U1B0 > g for the constant growth DDM to hold. This inequality ensures that the required rate of return for the stock is greater than the expected growth rate of dividends.

Question 18

The rate of return required by investors is estimated as:

Accepted Answer

The rate of return required by investors is typically composed of both the dividend yield (the amount of dividends paid out as a percentage of the stock price) and the expected capital gains yield (the expected increase in the stock price over time). Therefore, the rate of return required by investors is estimated as dividend yield plus expected capital gains yield.

Question 19

Use the following two statements to answer this question:

Accepted Answer

Both statements are correct. Statement I is correct because common shares do not have a requirement to pay dividends. Statement II is correct because the level of dividend payment for common shares is at the discretion of the company's management.

Question 20

Which of the following is a FALSE statement about the DDM?

Accepted Answer

The DDM (Dividend Discount Model) works well for firms that are non-cyclical and have steady growth in earnings and dividends, making statement A false.

Quiz 7: Equity Valuation

The current market value of the 500,000 preferred shares of Clumsy Sports Inc.is $25 million.If the shares pay an annual dividend of $5 on a par value of $85 and the risk-free rate is 5.5 percent,what is the implied risk premium?

The 800,000 preferred shares of Fantastic Services have a market value of $9,192,000 and a book value of $10,000,000.What is the dividend rate if the risk-free rate is 3.15 percent and the risk premium is 3.65 percent?

Manic Corporation issued 400,000 preferred shares with a book value of $10 million three years ago.The preferred shares pay an annual dividend of $2.What is the required return if the current market value of these preferred shares is $9.5 million?

The Dividend Discount Model (DDM) links common share prices to three important fundamentals: corporate profitability,the general level of interest rates,and risk.All else being equal,the DDM predicts that common share prices will be lower

The current market value of the 500,000 preferred shares of Clumsy Sports Inc.is $25 million.If the shares pay a quarterly dividend of $1.25 on a par value of $85 and the risk premium is 4.5 percent,what is the implied risk-free rate?

The dividend growth rate for a stable firm can be estimated as:

Use the following two statements to answer this question:

Manic Corporation issued 200,000 preferred shares with a book value of $10 million three years ago.If the required return is 8.42% and the current market value of these preferred shares is $9.5 million,what is the annual dividend?

How much would you pay for a share of stock today,if you expect it will pay a dividend of $2.50 each year and will sell for $58 one year from now? Assume your required rate of return on this stock is 13 percent.

Use the following two statements to answer this question:

How much would you pay for a share of stock today if you expect it will pay a dividend of $2.50 each year and will sell for $58 two years from now? Assume your required rate of return on this stock is 13 percent.

You paid $20 for one share of HyperTension Inc.today.What is the expected one-year holding period return if the stock pays a $1.25 dividend and sells for $21.50 one year from now?

Which of the following statements is TRUE?

Which of the following is TRUE about the implicit assumption of the DDM that "investors are rational"?

The Beautiful Mind Company's preferred stock is selling for $30 per share.What is the expected dividend of year four if the required rate of return is 7.5 percent?

Which of the following is not a correct statement of the Constant Growth DDM?

The rate of return required by investors is estimated as:

Use the following two statements to answer this question:

Which of the following is a FALSE statement about the DDM?