Question 1

Which of the following statements is true?

Accepted Answer

The constant growth dividend model (also known as the Gordon Growth Model) assumes that dividends grow at a constant rate in perpetuity. For the model to work and not result in a negative stock price or an unrealistic valuation, the required rate of return (R) must be greater than the dividend growth rate (g). This is because the model is based on the premise that the value of the stock is the present value of all future dividends, which must be discounted at a rate higher than they grow, to ensure the present value sums to a positive number.

Question 2

Each quarter, Transam, Inc., pays a dividend on its perpetual preferred stock. Today, the stock is selling at $83.45. If the required rate of return for such stocks is 10.5 percent, what is the quarterly dividend paid by the firm? (Do not round intermediate calculations. Round final answer to two decimal places.)

Accepted Answer

First, we need to find the annual dividend by using the formula:

Annual dividend = Required rate of return * Stock price

Annual dividend = 0.105 * $83.45 = $8.76

Since the stock pays a quarterly dividend, we need to divide the annual dividend by 4 to get the quarterly dividend:

Quarterly dividend = Annual dividend / 4 = $8.76 / 4 = $2.19

Therefore, the answer is C, $2.19, rounded to two decimal places.

Question 3

Suppose a firm's expected dividends for the next three years are as follows: D₁ = $1.10, D₂ = $1.20, and D₃ = $1.30. After three years, the firm's dividends are expected to grow at 5.00 percent per year. What should the current price of the firm's stock (P₀) be today if investors require a rate of return of 12.00 percent on the stock? (Do not round intermediate calculations. Round off final answer to the nearest $0.01)

Accepted Answer

The first step is to calculate the expected dividends in year 3 (D3): D3 = D2*(1+g) = $1.30*(1+0.05) = $1.365 Next, we can use the dividend discount model to calculate the stock price today: P₀ = (D1/(1+r)^1) + (D2/(1+r)^2) + (D3+P3)/(1+r)^3 P₀ = ($1.10/(1+0.12)^1) + ($1.20/(1+0.12)^2) + ($1.365/(1+0.12)^3) P₀ = $0.982 + $0.974 + $1.051 P₀ = $3.007 Finally, we add the present value of the expected future stock price at the end of year 3 (P3): P3 = D4/(r - g) = $1.365/(0.12 - 0.05) = $17.06 P₀ = $3.007 + ($17.06/(1+0.12)^3) P₀ = $3.007 + $13.734 P₀ = $16.74, rounded to the nearest cent. Therefore, the best choice is C.

Question 4

The National Bank of Columbia has issued perpetual preferred stock with a $100 par value. The bank pays a quarterly dividend of $1.40 on this stock. What is the current price of this preferred stock given a required rate of return of 8.5 percent? (Round off to two decimal places.)

Accepted Answer

The current price of a perpetual preferred stock can be calculated using the formula: Price = Dividend per period / Required rate of return. Here, the quarterly dividend is $1.40, and the annual dividend is $1.40 * 4 = $5.60. The required rate of return is 8.5%, or 0.085 in decimal form. Thus, Price = $5.60 / 0.085 = $65.88.

Question 5

Ajax Company has issued perpetual preferred stock with a par of $100 and a dividend of 5.5 percent. If the required rate of return is 7.75 percent, what is the stock's current market price? (Round off to the two decimal places.)

Accepted Answer

The price of a perpetual preferred stock is calculated using the formula: Price = Dividend / Required Rate of Return. Here, the dividend is 5.5% of $100, which is $5.50. The required rate of return is 7.75% or 0.0775. Thus, the price is $5.50 / 0.0775 = $70.97.

Question 6

The preferred stock of Acme International is selling currently at $110.35. If your required rate of return is 9.75 percent, what is the dividend paid by this stock? (Round off to the two decimal places.)

Accepted Answer

We can use the formula for dividend yield to find the dividend paid:
Dividend Yield = Annual Dividend / Stock Price
Rearranging the formula, we get: Annual Dividend = Dividend Yield x Stock Price
Since the required rate of return is 9.75%, the dividend yield is also 9.75%. Therefore,
Annual Dividend = 0.0975 x $110.35 = $10.76 (rounded off to the nearest cent)
Hence, the correct choice is C.

Question 7

Durango Water Works has an outstanding issue of preferred stock that has a par (maturity value) of $75.00. The stock, which pays a quarterly dividend of $1.10, will be retired by the firm in 20 years. If the preferred stock is currently selling for $68.00, what is the preferred stock's yield-to-maturity? (Round off to the nearest 0.01%)

Accepted Answer

The answer of Durango Water Works has an outstanding issue...

Question 8

Which of the following statements about preferred stock is FALSE?

Accepted Answer

While preferred stock dividends are typically fixed, failure to pay them does not generally result in default. However, if the company continues to miss preferred stock dividends, it may lead to a default on other securities like bonds.

Question 9

Discuss the significance of an active secondary market to both issuers of securities and to investors.

Accepted Answer

The answer of Discuss the significance of an active secondary...

Question 10

Lincoln, Inc. expects to pay no dividends for the next four years. It has projected a growth rate of 35 percent for the next four years. After four years, the firm will grow at a constant rate of 6 percent. Its first dividend to be paid in year 5 will be worth $4.25. If your required rate of return is 20 percent, what is the stock worth today? (Do not round intermediate calculations. Round final answer to two decimal places.)

Accepted Answer

The answer of Lincoln, Inc. expects to pay no dividends...

Question 11

Differentiate the characteristics of common and preferred stocks.

Accepted Answer

The answer of Differentiate the characteristics of common and preferred...

Question 12

The Columbia Consumer Products Co. has issued perpetual preferred stock with a $100 par value. The firm pays a quarterly dividend of $2.60 on this stock. What is the current price of this preferred stock given a required rate of return of 12.5 percent?

Accepted Answer

The annual dividend paid on the preferred stock is $2.60 x 4 = $10.40.
To calculate the price of the preferred stock, we can use the formula: Price = Dividend / Required Rate of Return.
Price = $10.40 / 0.125 = $83.20.
Therefore, the current price of the preferred stock is $83.20, which is option D.

Quiz 9: Stock Valuation