Question 1

Other things equal, a firm's sustainable growth rate could increase as a result of:
A) increasing the plowback ratio.
B) increasing the payout ratio.
C) decreasing the return on equity.
D)increasing total assets.

Accepted Answer

Sustainable growth rate is calculated as ROE x Plowback ratio. Therefore, increasing the plowback ratio, while keeping all other factors constant, will increase the sustainable growth rate.

Question 2

Under which of the following forms of market efficiency would stock prices always reflect fair value?
A) Weak-form efficiency
B) Semistrong-form efficiency
C) Strong-form efficiency
D)Semiweak-form efficiency

Accepted Answer

Under strong-form efficiency, all information, including insider information, is reflected in stock prices. Therefore, the stock prices always reflect the fair value.

Question 3

ABC common stock is expected to have extraordinary growth of 20% per year for 2 years, after which the growth rate will settle into a constant 6%. If the discount rate is 15% and the most recent dividend was $2.50, what should be the approximate current share price?
A) $31.16
B) $33.23
C) $37.39
D)$47.77

Accepted Answer

Price = ($2.50 × 1.2)/1.15 + ($2.50 × 1.2²)/1.15² + [($2.50 × 1.2² × 1.06)/(.15 - .06)]/1.15² = $37.39

Question 4

What should be the price for a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8%?
A) $22.86
B) $28.00
C) $42.00
D)$43.75

Accepted Answer

Price = $3.50/.08 = $43.75

Question 5

It is possible to ignore cash dividends that occur far into the future when using a dividend discount model because those dividends:
A) will most likely be paid to a different investor.
B) will most likely not be paid.
C) have an insignificant present value.
D)have a minimal, if any, potential rate of growth.

Accepted Answer

When using a dividend discount model, it is important to consider the present value of future cash dividends. However, dividends that occur far into the future may have a negligible present value, especially when discounted at a higher rate. Therefore, it is reasonable to ignore those dividends as they may not significantly affect the current stock price. Option C is the correct answer as it implies that these dividends have an insignificant present value.

Question 6

What is the plowback ratio for a firm that has earnings per share of $2.68 and pays out $1.75 per share in dividends?
A) 28.20%
B) 34.70%
C) 66.67%
D)71.80%

Accepted Answer

Plowback ratio = ($2.68 - 1.75)/$2.68 = .3470, or 34.70%

Question 7

What should you pay for a stock if next year's annual dividend is forecast to be $5.25, the constant-growth rate is 2.85%, and you require a 15.5% rate of return?
A) $31.25
B) $38.87
C) $41.50
D)$42.68

Accepted Answer

Price = $5.25/(.155 - .0285) = $41.50

Question 8

The expected return on a common stock is equal to:
A) [(1 + dividend yield) × (1 + capital appreciation rate)] - 1.
B) the capital appreciation rate + dividend yield.
C) (1 + capital appreciation rate)/(1 + dividend yield).
D)the capital appreciation rate - dividend yield.

Accepted Answer

The expected return on a common stock is the sum of the capital appreciation rate and the dividend yield. This is because the return on a stock comes from two sources: capital appreciation (the increase in the stock price) and dividends (the payments made to shareholders). Therefore, the correct formula is (capital appreciation rate + dividend yield). Option A is incorrect because it uses a formula that multiplies the two rates together and subtracts one. Option C is incorrect because it uses a formula with a fraction. Option D is incorrect because it subtracts the dividend yield from the capital appreciation rate instead of adding them together.

Question 9

A company with a return on equity of 15% and a plowback ratio of 60% would expect a constant-growth rate of:
A) 4%.
B) 9%.
C) 21%.
D)25%.

Accepted Answer

g = .15 × .60 = .09, or 9%

Question 10

What rate of return is expected from a stock that sells for $30 per share, pays $1.54 annually in dividends, and is expected to sell for $32.80 per share in one year?
A) 15.03%
B) 14.28%
C) 14.09%
D)14.47%

Accepted Answer

Expected return = ($32.80 + 1.54 - 30)/$30 = .1447, or 14.47%

Question 11

What would be the approximate expected price of a stock when dividends are expected to grow at a 25% rate for 3 years, then grow at a constant rate of 5%, if the stock's required return is 13% and next year's dividend will be $4.00?
A) $67.60
B) $62.08
C) $68.64
D)$73.44

Accepted Answer

Price = $4/1.13 + ($4 × 1.25)/1.13² + ($4 × 1.25²)/1.13³ + [($4 × 1.25² × 1.05)/(.13 - .05)]/1.13³ = $68.64

Question 12

The value of common stock will likely decrease if:
A) the investment horizon decreases.
B) the growth rate of dividends increases.
C) the discount rate increases.
D)dividends are discounted back to the present.

Accepted Answer

If the discount rate increases, the present value of future cash flows (including dividends) decreases, which can lead to a decrease in the value of common stock.

Question 13

A positive value for PVGO suggests that the firm has:
A) a positive return on equity.
B) a positive plowback ratio.
C) investment opportunities with superior returns.
D)a high rate of constant growth.

Accepted Answer

PVGO (present value of growth opportunities) measures the present value of the company's future investments that are expected to generate returns exceeding the cost of capital. A positive PVGO indicates that the company has investment opportunities with superior returns, which can lead to future growth and increased shareholder value.

Question 14

What constant-growth rate in dividends is expected for a stock valued at $32.40 if next year's dividend is forecast at $2.20 and the appropriate discount rate is 13.6%?
A) 7.02%
B) 6.59%
C) 6.81%
D)7.38%

Accepted Answer

$32.40 = $2.20/(.136 - g); g = .0681, or 6.81%

Question 15

Dani's just paid an annual dividend of $6 per share. What is the dividend expected to be in five years if the growth rate is 4.2%?
A) $7.07
B) $7.37
C) $7.14
D)$7.44

Accepted Answer

DIV₃ = $6 × 1.042⁵ = $7.37

Question 16

A stock currently sells for $50 per share, has an expected return of 15%, and an expected capital appreciation rate of 10%. What is the amount of the expected dividend?
A) $2.50
B) $2.75
C) $3.00
D)$3.50

Accepted Answer

Dividend yield = .15 - .10 = .05Expected dividend = .05 × $50 = $2.50

Question 17

What price would you pay today for a stock if you require a rate of return of 13%, the dividend growth rate is 3.6%, and the firm recently paid an annual dividend of $2.50?
A) $27.55
B) $30.28
C) $26.60
D)$31.37

Accepted Answer

Price = ($2.50 × 1.036)/(.13 - .036) = $27.55

Question 18

When valuing stock with the dividend discount model, the present value of future dividends will:
A) change depending on the time horizon selected.
B) remain constant regardless of the time horizon selected.
C) remain constant regardless of the rate of growth.
D)always equal the present value of the terminal price.

Accepted Answer

The answer of When valuing stock with the dividend discount...

Question 19

If the dividend yield for year 1 is expected to be 5% based on a stock price of $25, what will the year 4 dividend be if dividends grow annually at a constant rate of 6%?
A) $1.33
B) $1.49
C) $1.58
D)$1.67

Accepted Answer

DIV₄ = (.05 × $25) × 1.06³ = $1.49

Question 20

Which of the following situations accurately describes a growth stock, assuming that each firm has a required return of 12%?
A) A firm with PVGO = $0.
B) A firm with investment opportunities yielding 10%.
C) A firm with investment opportunities yielding 15%.
D)A firm with PVGO < $0.

Accepted Answer

A growth stock is a stock of a company that is expected to grow at a rate significantly above the average growth for the market. Investment opportunities with a yield of 15% indicate that the company has a high growth potential, which is consistent with the definition of a growth stock. A required return of 12% means that investors expect a return above that of the risk-free rate, therefore, investments with a yield above the required return are desirable. Options A, B, and D do not accurately describe a growth stock.

Quiz 7: Valuing Stocks

Other things equal, a firm's sustainable growth rate could increase as a result of:

Under which of the following forms of market efficiency would stock prices always reflect fair value?

ABC common stock is expected to have extraordinary growth of 20% per year for 2 years, after which the growth rate will settle into a constant 6%. If the discount rate is 15% and the most recent dividend was $2.50, what should be the approximate current share price?

What should be the price for a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8%?

It is possible to ignore cash dividends that occur far into the future when using a dividend discount model because those dividends:

What is the plowback ratio for a firm that has earnings per share of $2.68 and pays out $1.75 per share in dividends?

What should you pay for a stock if next year's annual dividend is forecast to be $5.25, the constant-growth rate is 2.85%, and you require a 15.5% rate of return?

The expected return on a common stock is equal to:

A company with a return on equity of 15% and a plowback ratio of 60% would expect a constant-growth rate of:

What rate of return is expected from a stock that sells for $30 per share, pays $1.54 annually in dividends, and is expected to sell for $32.80 per share in one year?

What would be the approximate expected price of a stock when dividends are expected to grow at a 25% rate for 3 years, then grow at a constant rate of 5%, if the stock's required return is 13% and next year's dividend will be $4.00?

The value of common stock will likely decrease if:

A positive value for PVGO suggests that the firm has:

What constant-growth rate in dividends is expected for a stock valued at $32.40 if next year's dividend is forecast at $2.20 and the appropriate discount rate is 13.6%?

Dani's just paid an annual dividend of $6 per share. What is the dividend expected to be in five years if the growth rate is 4.2%?

A stock currently sells for $50 per share, has an expected return of 15%, and an expected capital appreciation rate of 10%. What is the amount of the expected dividend?

What price would you pay today for a stock if you require a rate of return of 13%, the dividend growth rate is 3.6%, and the firm recently paid an annual dividend of $2.50?

When valuing stock with the dividend discount model, the present value of future dividends will:

If the dividend yield for year 1 is expected to be 5% based on a stock price of $25, what will the year 4 dividend be if dividends grow annually at a constant rate of 6%?

Which of the following situations accurately describes a growth stock, assuming that each firm has a required return of 12%?