Question 1

Mega Inc. is expected to pay a dividend of $2.00 per share next year. The dividends are expected togrow at a constant rate of 5% per year indefinitely. If investors require a 12% return on Mega stock,what is the current price?

Accepted Answer

Using the constant growth model or Gordon model: 
P = D/(r-g) 
where P is the current price of the stock, 
D is the expected dividend next year, 
r is the required rate of return or cost of equity, and 
g is the expected growth rate of dividends.

Substituting, 
P = $2.00/(0.12-0.05) 
P = $28.57

Therefore, the current price of the stock is $28.57.

Question 2

Interest rate risk and the time to maturity have a relationship that is best characterized as

Accepted Answer

Interest rate risk increases with longer time to maturity, indicating a direct relationship.

Question 3

Common stock in a business that was purchased for $100,000 and has a discounted cash flow value of $340,000 would be worth __________ per share in an efficient market; there are 100,000 shares outstanding.

Accepted Answer

The discounted cash flow value of the entire business is $340,000, which means the value per share is $3.40 ($340,000 divided by 100,000 shares). In an efficient market, the stock would trade at or around this value per share.

Question 4

A firm has a balance sheet common shares account with a value of $260,000. The firm has 10,000common shares outstanding. If the retained earnings account has a value of $250,000, the commonstock originally sold for

Accepted Answer

The answer of A firm has a balance sheet common...

Question 5

The cost of preferred stock is

Accepted Answer

Preferred stock typically has a higher cost than long-term debt due to its riskier nature but is generally cheaper than common stock because it has a fixed dividend and less risk than common equity.

Question 6

The yield to maturity on a bond with a price equal to its par value will

Accepted Answer

When a bond is priced at its par value (which is typically $1,000), the yield to maturity will always be equal to the coupon rate. The coupon rate is the interest rate that the bond pays annually, and when the bond is priced at par, the coupon payments are equal to the required rate of return (yield to maturity). Therefore, the yield to maturity and coupon rate will be the same.

Question 7

The yield curve in an economic period of high inflation would most likely be

Accepted Answer

In a period of high inflation, interest rates are expected to rise in the future to combat inflation. This causes long-term bonds to suffer as their fixed interest payments become worth less in the future due to inflation. As a result, investors will demand higher yields on long-term bonds, causing the yield curve to slope upward.

Question 8

__________in the beta coefficient normally causes __________in the required return and therefore __________in the price of the stock, all else remaining the same.

Accepted Answer

- An increase in interest rates will increase the cost of borrowing for companies, which in turn can decrease their profitability and reduce investor demand for their stock, thus causing a decrease in the price of the stock. This is the first part of the scenario in the question.
- An increase in corporate tax rates will lower the after-tax earnings of companies and reduce investor demand for their stock, thus causing a decrease in the price of the stock. This is the second part of the scenario in the question.
- A decrease in inflation will generally strengthen the purchasing power of the currency and increase investor confidence in the economy and the stock market, thus causing an increase in the price of the stock. However, this effect may not be strong enough to overcome the negative effects of the first two factors stated above, hence resulting in a decrease in the price of the stock overall. This is the third part of the scenario in the question.

Question 9

If a corporate bond is issued with a coupon rate that varies directly with the required return, theprice of the bond will

Accepted Answer

If the coupon rate varies directly with the required return, the bond's price will equal the face value because the bond's yield will always match the market's required return.

Question 10

Hewitt Packing Company has an issue of $1,000 par value bonds with a 14 percent annual couponinterest rate. The issue has ten years remaining to the maturity date. Bonds of similar risk arecurrently selling to yield a 12 percent rate of return. The current value of each Hewitt bond is __________.

Accepted Answer

To calculate the current value of each Hewitt bond, we can use the formula for present value of a bond:

PV = (C / r) * (1 - (1 + r)^(-n)) + (F / (1 + r)^n)

Where:
C = annual coupon payment = 14% * $1,000 = $140
r = current yield to maturity = 12%
n = remaining years to maturity = 10
F = par value = $1,000

Plugging in the values, we get:

PV = ($140 / 0.12) * (1 - (1 + 0.12)^(-10)) + ($1,000 / (1 + 0.12)^10)
PV = $1,113

Therefore, the current value of each Hewitt bond is $1,113.

Question 11

The price of a bond with a fixed coupon rate and the market required return have a relationshipthat is best described as

Accepted Answer

The price of a bond and its required return have an inverse relationship, meaning that as the required return increases, the bond price will decrease, and vice versa. This is because investors will only be willing to pay a certain price for a bond based on how much return they can earn from it compared to other investments in the market. Therefore, when the required return increases, the bond's fixed coupon rate becomes less attractive, causing its price to decrease.

Question 12

Following the theory of the "efficient market hypothesis" all of the following are true EXCEPT

Accepted Answer

The efficient market hypothesis theory states that securities are usually fairly priced and their expected returns equal their required returns, reflecting all public information available at any point in time. Therefore, investors should not waste their time trying to find and capitalize on mispriced securities. However, the Warren Buffets of the market have proven that stocks are not fully and fairly priced, so investors should spend time searching for mispriced (over- or under-valued) stocks. This contradicts the efficient market hypothesis theory, making option D the correct answer.

Question 13

In the present value model, risk is generally incorporated into

Accepted Answer

In the present value model, risk is generally incorporated into the discount rate. This is because the discount rate reflects the time value of money and also incorporates the risk factor. The higher the risk, the higher the discount rate, and the lower the present value of future cash flows. Therefore, the discount rate is adjusted to incorporate the risk associated with the investment.

Question 14

A firm has an issue of $1,000 par value bonds with a 9 percent stated interest rate outstanding. Theissue pays interest annually and has 20 years remaining to its maturity date. If bonds of similar riskare currently earning 11 percent, the firm's bond will sell for  __________today.

Accepted Answer

When bonds of similar risk are currently earning 11 percent, the firm's bond with a stated interest rate of 9 percent will need to sell at a discount to make up for the difference in the interest rates. To calculate the bond's price, use the formula: 
Bond price = (annual interest payment / current market interest rate) x [1 - (1 / (1 + current market interest rate)^number of years until maturity)]
Annual interest payment = $1,000 x 9% = $90
Current market interest rate = 11%
Number of years until maturity = 20
Plug in these values: 
Bond price = ($90 / 0.11) x [1 - (1 / (1 + 0.11)^20)]
Bond price = $817.27
However, this bond has a par value of $1,000, so the actual selling price will be slightly higher than the calculated value. The closest answer choice is B, $841.

Question 15

__________is the value of the firm's ownership in the event that all assets are sold for their exact accounting value and the proceeds remaining after paying all liabilities (including preferred stock)are divided among common stockholders.

Accepted Answer

Book value refers to the accounting value of a company's assets minus its liabilities. In the context of the question, it specifies the value of common stockholders' equity. Therefore, the correct option is A - Book value. The other options are not relevant to the given scenario.

Question 16

A firm has a balance sheet common shares account with a value of $540,000. The firm has 40,000common shares outstanding. If the preferred shares account has a value of $250,000, the commonstock originally sold for

Accepted Answer

To find the value of each common share, we need to subtract the preferred shares value from the total common and preferred shares value and then divide the result by the number of common shares outstanding.

Total common and preferred shares value = $540,000 + $250,000 = $790,000

Value per common share = ($790,000 - $250,000) / 40,000 = $13.50

Therefore, the common stock originally sold for $13.50/share.

Question 17

__________is the actual amount each common stockholder would expect to receive if the firm's assets are sold, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders.

Accepted Answer

Liquidation value is the actual amount that each common stockholder would expect to receive if the company's assets are sold, after paying off all liabilities and preferred stockholders. It is the amount each shareholder will receive in case of liquidation of the company.

Question 18

If the required return is less than the coupon rate, a bond will sell at

Accepted Answer

If the required return is less than the coupon rate, investors will perceive the bond to be more valuable than its par value and will be willing to pay more than par in order to secure the higher coupon payments. This results in the bond selling at a premium.

Question 19

What is the yield to maturity, to the nearest percent, for the following bond: current price is $908, coupon rate is 11 percent, $1,000 par value, interest paid annually, eight years to maturity?

Accepted Answer

To calculate the yield to maturity (YTM), we need to use the formula:
P = (C / r) x [1 - 1 / (1 + r)^n] + FV / (1 + r)^n
where:
P = current price of the bond
C = annual coupon payment
r = YTM
n = number of years to maturity
FV = face value or par value of the bond

Substitute the given values into the formula:

908 = (110 / r) x [1 - 1 / (1 + r)^8] + 1000 / (1 + r)^8

We can solve this equation by trial and error or by using a financial calculator. The result is r = 13% (rounded to the nearest percent).

Therefore, the best choice is D.

Question 20

Chicken Delight has entered 28 markets and has built a stable consumer base; the company also hasmany growth prospects if it can find competent local working-partners. Last year Chicken Delightpaid a $0.45 per share dividend. The company shares were trading at $7.20 at the beginning of the year and $7.84 at the end. Chicken Delights capital gain yield last year was

Accepted Answer

The capital gain yield is calculated as (Ending Price - Beginning Price) / Beginning Price. Here, it is ($7.84 - $7.20) / $7.20 = 0.0889 or 8.89%.

Quiz 8: Valuation of Financial Securities