Question 1

In the formula, ,what does g represent?

Accepted Answer

In the formula, the value represented by 'g' is the constant growth rate.

Question 2

What is the required rate of return on a share that is expected to pay a constant dividend of $3.60 in perpetuity and is priced at $27.50?

Accepted Answer

The required rate of return can be calculated using the dividend discount model for a perpetuity, which is Dividend / Price. Therefore, it's $3.60 / $27.50 = 0.1309 or 13.09% per annum.

Question 3

Which of the following constitutes a difference between debt and equity?

Accepted Answer

A) Debt refers to borrowing money, hence it involves predictable cash flows such as interest payments and repayment of principal, whereas equity involves ownership in the company and its cash flows are uncertain, determined by the company's performance and dividend payments (if any).
B) Debt holders have priority in claiming the corporation's assets in the case of bankruptcy, while equity holders have a residual claim on the assets after all debts are paid off. 
C) Debt has a fixed maturity date whereas equity often has an indefinite life, as ownership in the company persists until the shares are sold or the company is dissolved.

Question 4

Silo Builders recently paid a dividend of $0.72.Their ordinary shares are currently trading at $18.72 in the market.Silo Builders' shareholders require a return of 8% p.a.What is the implied rate of growth of Silo Builders' dividends?

Accepted Answer

Using the Gordon Growth Model, we can calculate the implied rate of growth of Silo Builders' dividends:

$0.72 / ($18.72 x (1 + 0.08)) = 0.04 or 4.00%

Therefore, the answer is D, 4.00%.

Question 5

Which of the following does not constitute a feature of a debt security?

Accepted Answer

A debt security represents a loan that the holder has made to the issuer, and does not give the holder any ownership interest in the firm. Option A and D are both features of a debt security, as the principle is repaid at a fixed time and the return is fixed for the life of the security. Option B is also a feature of a debt security, as the holders have priority claim against the assets of the firm in case of liquidation. Option C, however, is not a feature of a debt security, as it is associated with equity securities such as common stock, where the holder has an ownership interest in the company.

Question 6

XHZ Ltd has recently paid a dividend of $0.23.This dividend is expected to grow at a constant rate of 3% p.a.The company's equity holders require a return of 11.95% on equity investments.What is XHZ Ltd's current share price?

Accepted Answer

The current share price can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity with growth) as follows: P = D0 * (1 + g) / (r - g), where P is the price, D0 is the current dividend, g is the growth rate, and r is the required rate of return. Substituting the given values: P = $0.23 * (1 + 0.03) / (0.1195 - 0.03) = $2.65.

Question 7

If you require an 11% rate of return,how much would you pay now for a bond with a face value of $3,000,pays $120 interest each year and matures in 11 years' time? Round your answer to the nearest $10.

Accepted Answer

To find the present value of the bond, calculate the present value of the interest payments (an annuity) and the present value of the face value (a lump sum) using the required rate of return (11%). The present value of the interest payments is calculated using the formula for the present value of an annuity, and the present value of the face value is calculated using the formula for the present value of a lump sum. Adding these two present values gives approximately $1,700.

Question 8

What is the market price (to the nearest dollar)of a 16% p.a.quarterly coupon bond with a face value of $100,five years to go until maturity when the current market yield is 12% p.a.?

Accepted Answer

The market price of a bond can be calculated using the formula for the present value of its future cash flows, which include the periodic coupon payments and the face value repayment at maturity. For a bond with a 16% annual coupon rate, paid quarterly, the coupon payment per quarter is $4 (16% of $100, divided by 4). With a market yield of 12% per annum, the quarterly yield is 3% (12% divided by 4). The bond has 20 quarters left until maturity (5 years times 4 quarters per year).The present value of the coupon payments (an annuity) can be calculated using the formula: PV = C * [1 - (1 + r)^-n] / r, where C is the coupon payment per period, r is the market yield per period, and n is the total number of periods. Substituting the values, we get: PV(coupons) = $4 * [1 - (1 + 0.03)^-20] / 0.03 ≈ $61.35.The present value of the face value (a lump sum) can be calculated using the formula: PV = F / (1 + r)^n, where F is the face value. Substituting the values, we get: PV(face value) = $100 / (1 + 0.03)^20 ≈ $55.21.Adding the present values of the coupon payments and the face value gives the bond's market price: $61.35 + $55.21 ≈ $116.56. Since the options are rounded to the nearest dollar and there's no option exactly matching $116.56, the closest option is B) $114.

Question 9

Which of these answers best describes the cost of debt?

Accepted Answer

The cost of debt can be defined as the discount rate that equates the cash inflows (interest and principal) with the current bond price. It is also one of the components of the firm's cost of capital, which includes other sources of funding such as equity. Furthermore, the required rate of return on debt is influenced by the perceived risk of the borrower and the overall market conditions. Therefore, all of the options (A, B, and C) best describe the cost of debt.

Question 10

Koromiko Cheese Ltd generated an EPS this year of $1.80 and paid a dividend of $1.00 per share.Koromiko Cheese has recently been able to generate a return of 10.75% p.a.on its (book)equity base.If these numbers are assumed to be fairly stable,what will be Koromiko Cheese's expected future growth rate?

Accepted Answer

The answer of Koromiko Cheese Ltd generated an EPS this...

Question 11

The value of a share is given by the present value of which cash flows?

Accepted Answer

The value of a share is typically determined by the present value of future dividends only, as these are the expected cash flows that investors will receive. Current or most recent dividends are not directly used in valuation models like the Dividend Discount Model (DDM), which focuses on future dividends.

Question 12

What is the price of a share that recently paid a dividend of $0.25,assuming that the dividend is expected to remain unchanged in the future and that the appropriate cost of equity is 12.5% p.a.?

Accepted Answer

The answer of What is the price of a share...

Question 13

Martell Ltd is expected to generate an EPS next year of $0.80 and its shares are currently priced in the marketplace at $13.11.Lannister Ltd is expected to generate an EPS next year of $0.51 and its shares are currently priced in the marketplace at $9.20.Baratheon Ltd is expected to generate an EPS next year of $0.23 and its shares are currently priced in the marketplace at $5.61.Stark Ltd is expected to generate an EPS next year of $0.56 and its shares are currently priced in the marketplace at $8.85.These companies all operate in the same industry,are expected to all have the same growth prospects and all have the same risk.The industry P/E prospective ratio is known to be 17x.Based upon the P/E ratios,which of the following would be the best investment strategy?

Accepted Answer

The answer of Martell Ltd is expected to generate an...

Question 14

Which of the following describes the difference between the returns on debt and equity?

Accepted Answer

The return on debt is typically fixed and outlined in the debt agreement or trust deed, guaranteeing lenders a certain return. In contrast, the return on equity (such as dividends) can vary and is often decided by the company's management based on its performance and profit distribution policies.

Question 15

When valuing a company's real asset cash flows,which cash flows should be considered? The value of a firm is given by its free cash flows discounted by which of the following?

Accepted Answer

When valuing a company's real asset cash flows, only the cash flows from real assets after reinvestment costs should be considered. The value of a firm is given by its free cash flows discounted by cash flows from real assets after reinvestment costs. This is because reinvestment is necessary to maintain and grow the value of the company's real assets, and should be factored in when determining the value of the company.

Question 16

What is the market price (to the nearest dollar)of a 12% p.a.quarterly coupon bond with a face value of $100,three years to go until maturity when the current market yield is 8% p.a.?

Accepted Answer

The correct answer is A because the market price of the bond is $111. This is because the bond has a face value of $100, a coupon rate of 12% p.a., and three years to go until maturity. The current market yield is 8% p.a., so the bond's price is $100 / (1 + 0.08/4)^12 = $111.

Question 17

What is the required rate of return on a share that is expected to pay a constant dividend of $4.50 in perpetuity and is priced at $47.50?

Accepted Answer

The required rate of return can be calculated using the formula for a perpetuity: Required Rate of Return = Dividend / Price = $4.50 / $47.50 = 0.0947 or 9.47%.

Question 18

WineMaster Ltd generated an EPS this year of $0.90 and paid a dividend of $0.30 per share.WineMaster has recently been able to generate a return of 7.75% p.a.on its (book)equity base.If these numbers are assumed to be fairly stable,what will be WineMaster's expected future growth rate?

Accepted Answer

The formula for calculating the sustainable growth rate is (1 - dividend payout ratio) x return on equity. Here, the dividend payout ratio is 0.3/0.9 = 0.33. So, the sustainable growth rate is (1 - 0.33) x 0.0775 = 0.0517 or 5.17%. Therefore, the best choice is B.

Question 19

Jindabyne Brewing Ltd (JBL)recently paid a dividend of $0.72.This dividend is expected to grow at a constant rate of 3% p.a.The company's shareholders require a return of 6% p.a.on their invested capital.Assuming that these figures are accurate what will be JBL's share price in two year's time?

Accepted Answer

The correct answer is A because the share price in two years' time can be calculated using the formula:Share price = Dividend / (Required return - Dividend growth rate)= 0.72 / (0.06 - 0.03)= $26.23

Question 20

Endeavour Enterprises is expected to pay a dividend of $1.22 at the end of the current year and analysts predict that dividends are expected to grow at a constant rate of 9% p.a.after that.If Endeavour Enterprises' shareholders require a return of 8% p.a.on equity capital provided to the firm what will be its current share price?

Accepted Answer

The constant dividend growth model (Gordon Growth Model) cannot be used when the required rate of return is less than the growth rate, as it would result in a negative or undefined price.

Quiz 3: Valuation of Shares and Bonds