Question 1

Jumbo Transport,an air-cargo company,expects to have earnings per share of $2.50 in the coming year.It decides to retain 20% of these earnings in order to lease new aircraft.The return on this investment will be 25%.If its equity cost of capital is 12%,what is the expected share price of Jumbo Tranport?

Accepted Answer

D) D1 = 2.5 × 0.8 = 2; g = 0.2 × 0.25 = 0.05; P0 = 2 / (0.12 - 0.05) = $28.57

Question 2

You expect that Bean Enterprises will have earnings per share of $2 for the coming year.Bean plans to retain all of its earnings for the next three years.For the subsequent two years,the firm plans on retaining 50% of its earnings.It will then retain only 25% of its earnings from that point forward.Retained earnings will be invested in projects with an expected return of 20% per year.If Bean's equity cost of capital is 12%,then the price of a share of Bean's stock is closest to:

Accepted Answer

C)
 11ea4813_56bc_4977_a73a_bd4d53cb34a1_TB1618_00 
P₀ = 1.73 / (1.12)⁴ + 1.90 / 1.12⁵ + (3.14 / (0.12 - 0.05)) / 1.12⁵ = 27.63
Each g is calculated as the 20% return on the projects × the retention ratio.

Question 3

Kirkevue Industries pays out all its earnings as dividends and has a share price of $24.In order to expand,Kirkevue announces it will cut its dividend payments from $2.00 to $1.80 per share and reinvest the retained funds.What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged?

Accepted Answer

A) re1 = 2/24 = 8.33%; re2 = 1.8/24 = 7.5%; growth rate = 8.33 - 7.5 = 0.83%

Question 4

Spacefood Products will pay a dividend of $2.40 per share at the end of this year.It is expected that this dividend will grow by 3% per year each year in the future.What will be the current value of a single share of Spacefood's stock if the firm's equity cost of capital is 10%?

Accepted Answer

D) P0 = 2.4/(0.10 - 0.03) = $34.29

Question 5

Assuming everything else remains unchanged,how does a firm's decision to increase its dividend-payout ratio affect its growth rate?

Accepted Answer

The answer of Assuming everything else remains unchanged,how does a...

Question 6

Gremlin Industries will pay a dividend of $1.80 per share at the end of this year.It is expected that this dividend will grow by 4% per year each year in the future.The current price of Gremlin's stock is $22.40 per share.What is Gremlin's equity cost of capital?

Accepted Answer

B) Cost of capital = 1.8 / 22.40 + 0.04 = 12%

Question 7

JRN Enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and use the extra funds to expand its operations.Prior to this announcement,JRN's dividends were expected to grow at 4% per year and JRN's stock was trading at $25.00 per share.With the new expansion,JRN's dividends are expected to grow at 8% per year indefinitely.Assuming that JRN's risk is unchanged by the expansion,the value of a share of JRN after the announcement is closest to:

Accepted Answer

A) Two steps.
Step 1: Solve for rE:
rE = Div₁ / P₀ + g = 2.50 / 25.00 + 0.04 = 0.14 or 14%
Step 2: Solve for new stock price:
P₀ = Div₁ / (rE - g) = 1.50 / (0.14 - 0.08) = 25.00

Question 8

Xport International just announced that it plans to cut its dividend from $1.75 to $1.00 per share and use the extra funds to expand its operations.Prior to this announcement,Xport's dividends were expected to grow at 5% per year and Xport's stock was trading at $35.00 per share.With the new expansion,Xport's dividends are expected to grow at 7% per year indefinitely.Assuming that Xport's risk is unchanged by the expansion,the value of a share of Xport after the announcement is closest to:

Accepted Answer

B) Two steps.
Step 1: Solve for rE:
rE = Div₁ / P₀ + g = 1.75 / 35.00 + 0.05 = 0.10 or 10%
Step 2: Solve for new stock price:
P₀ = Div₁ / (rE - g) = 1.00 / (0.10 - 0.07) = 33.33

Question 9

Kilbright Corporation stock is currently trading at $73.29 per share and pays a dividend of $3.14 per share this year.The company's cost of equity is 13%.What is the expected annual growth rate of the company's dividends?

Accepted Answer

E) Growth rate = 0.13 - 3.14 / 73.39 = 8.7%

Question 10

Von Bora Corporation (VBC)is expected to pay a $2.00 dividend at the end of this year.If you expect VBC's dividend to grow by 5% per year forever and VBC's equity cost of capital is 13%,then the value of a share of VBS stock is closest to:

Accepted Answer

A) P₀ = Div₁ / (rE - g) = 2.00 / (0.13 - 0.05) = $25.00

Question 11

Sunnyfax Publishing pays out all its earnings and has a share price of $38.In order to expand,Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds.Once the funds are reinvested,they are expected to grow at a rate of 12%.If the reinvestment does not affect Sunnyfaxs equity cost of capital,what is the expected share price as a consequence of this decision?

Accepted Answer

C) cost of capital = 3/38 = 0.08; g = 0.33 × 0.12 = 0.04;
P0 = 2 / (0.08 -0.04) = $50

Question 12

You expect KT industries (KTI)will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.KTI's return on new investments is 15% and their equity cost of capital is 12%.The expected growth rate for KTI's dividends is closest to:

Accepted Answer

B) g = retention rate × return on new investment
= (3.00 - 1.50) / 3.00 × 0.15 = 0.075 or 7.5%

Question 13

NoGrowth Industries presently pays an annual dividend of $1.50 per share and it is expected that these dividend payments will continue indefinitely.If NoGrowth's equity cost of capital is 12%,then the value of a share of NoGrowth's stock is closest to:

Accepted Answer

D) P₀ = Div₁ / (rE - g) = $1.50 / (0.12 - 0) = $12.50

Question 14

The Sisyphean Company's common stock is currently trading for $25.00 per share.The stock is expected to pay a $2.50 dividend at the end of the year and the Sisyphean Company's equity cost of capital is 14%.If the dividend payout rate is expected to remain constant,then the expected growth rate in the Sisyphean Company's earnings is closest to:

Accepted Answer

C) P₀ = Div₁ / (rE - g) = 25.00 = 2.50 / (0.14 - g), so g = 0.04

Question 15

Avril Synchronistics will pay a dividend of $1.30 per share this year.It is expected that this dividend will grow by 5% each year in the future.What will be the current value of a single share of Avril's stock if the firm's equity cost of capital is 14%?

Accepted Answer

C) P0 = 1.3/(0.14 - 0.05) = $14.44

Question 16

Luther Industries has a dividend yield of 4.5% and and a cost of equity capital of 12%.Luther Industries' dividends are expected to grow at a constant rate indefinitely.The growth rate of Luther's dividends is closest to:

Accepted Answer

A) rE = Div₁ / P₀ + g
0.12 = 0.045 + g, so g = 0.075

Question 17

Sinclair ᴾʰᵃʳᵐᵃᶜᵉᵘᵗᶦᶜᵃˡˢ,a small drug company,develops a vaccine that will protect against Helicobacter pylori,a bacteria that is the cause of a number of diseases of the stomach.It is expected that Sinclair ᴾʰᵃʳᵐᵃᶜᵉᵘᵗᶦᶜᵃˡˢ will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time.Earnings were $1.20 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years.After this time,it is expected growth will drop to 5% and stay there for the expected future.Four years from now Sinclair will pay dividends that are 75% of its earnings.If its equity cost of capital is 10%,what is the value of a share of Sinclair ᴾʰᵃʳᵐᵃᶜᵉᵘᵗᶦᶜᵃˡˢ ᵗᵒᵈᵃʸ?

Accepted Answer

B) E3 = $3.29 D3 =2.470
E4 = $3.4574; D4 = $2.5931; D5 = 2.5931; P4 = 2.5931 / (0.10 - 0.05) = 49.392;
P0 = (49.392 + 2.470) / (1.10)^3 = $38.96

Question 18

You expect KT industries (KTI)will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.KTI's return on new investments is 15% and their equity cost of capital is 12%.The value of a share of KTI's stock is closest to:

Accepted Answer

C) g = retention rate × return on new investment
= (3.00 - 1.50) / 3.00 × 0.15 = 0.075 or 7.5%
P₀ = Div₁ / (rE - g) = 1.50 / (0.12 - 0.075) = 33.33

Question 19

Adelaide Industries expects to have earnings per share of $3.20 in the coming year.Adelaide has a return on new investment of 11%.If the firm's dividend payout rate is 60%,and its equity cost of capital is 8%,what is the value of Adelaide's stock?

Accepted Answer

B) Div = EPS × Dividend Payout Rate = 3.20 × 0.60 = $1.92
g = Retention rate × return on new investment = 0.4 × 0.11 = 4.4%
P = Div/(r - g) = 1.92/(0.08 - 0.044) = $53.33

Question 20

A company has stock which costs $42.00 per share and pays a dividend of $2.50 per share this year.The company's cost of equity is 8%.What is the expected annual growth rate of the company's dividends?

Accepted Answer

A) Growth rate = 0.08 - 2.5 / 42 = 2%

Quiz 7: Valuing Stocks