Question 1

Geothermal Corp.just announced good news: Its earnings have increased by 20%.Most investors had anticipated an increase of 25%.Will Geothermal's stock price increase or decrease when the announcement is made?

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Question 2

Moonshine Industries has produced a barrel per week for the past 20 years but cannot grow because of certain legal hazards.It earns $25 per share per year and pays it all out to stockholders.The stockholders have alternative,equivalent-risk ventures yielding 20% per year on average.How much is one share of Moonshine worth? Assume the company can keep going indefinitely.

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Question 3

When new information becomes available in the market,evidence suggests that:

Accepted Answer

Recent research has shown that stock prices will adjust rapidly to new information becoming available in the market. This is due to increased use of technology and faster dissemination of news. Additionally, high-frequency traders and algorithms are able to react very quickly to new information, further accelerating the adjustment of stock prices.

Question 4

How do you estimate expected rates of return in the constant-growth dividend discount model?

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Question 5

Show the breakdown of stock price between a firm's assets that are already in place and its present value of growth opportunities,assuming: next year's expected earnings equal $5.00,13% required rate of return,17% return on equity,and 45% plowback ratio.

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Question 6

The statement that there are no free lunches on Wall Street suggests that:

Accepted Answer

The statement that there are no free lunches on Wall Street implies that security prices reflect all available information, as any opportunity for abnormal returns via technical or fundamental analysis would be already priced in. It also does not necessarily have anything to do with the efficiency of the market or the capitalist nature of food purveyors on Wall Street.

Question 7

What are some common errors investors make in assessing the probability of uncertain outcomes? How did such errors reinforce the dot-com boom?

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Question 8

An example that specifically contradicts strong-form market efficiency in U.S.stock markets is that:

Accepted Answer

The observation of excess profits in cases of insider trading is a violation of strong-form market efficiency, which suggests that all information, including insider information, is already reflected in stock prices. If insider trading can lead to excess profits, it implies that the market is inefficient, and some participants have an unfair advantage over others.

Question 9

For a firm that expects earnings next year of $10.00 per share,has a plowback ratio of 35%,a return on equity of 20%,and a required return of 15%,show the current stock value and next year's expected stock value,assuming that growth is to be constant.

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Question 10

Given that markets are efficient,what is the most logical explanation of the fact that a portfolio manager can outperform the S&P 500 by 5% annually?

Accepted Answer

The most logical explanation for a portfolio manager outperforming the S&P 500 by 5% annually is that the manager's results have not been adjusted for the riskiness of the portfolio. The S&P 500 is considered a benchmark for the stock market and is inherently diversified, while a portfolio manager's portfolio may be more focused or concentrated, leading to higher risk and higher returns. Therefore, if the manager's portfolio is riskier than the S&P 500, it could still outperform the benchmark without necessarily indicating superior stock selection or insider information.

Question 11

Show numerically that investment horizon has no bearing on current stock price.For your illustration assume investment horizons of 3 versus 5 years and the following facts: The stock is correctly priced at $40.00,has a required return of 17%,a growth rate of 7%,and has just paid a $3.74 dividend.

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Question 12

How can an analyst feel comfortable in stating that the value of a stock is equal to the discounted value of all future dividends when a company may pay dividends indefinitely and it is virtually impossible to predict dividends beyond some reasonable horizon?

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Question 13

Explain the relationships among the earnings-price (E/P)ratio,required rate of return,and present value of growth opportunities.

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Question 14

How does competition among investors lead to efficient markets?

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Question 15

Discuss (with formula)the general dividend discount model and its three major submodels as introduced in the chapter.

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Question 16

Develop a current stock value for a firm that is expected to have extraordinary growth of 25% for 4 years,after which it will face more competition and slip into a constant-growth rate of 5%.Its required return is 14% and next year's dividend is expected to be $5.00.

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Question 17

Your broker suggests that you can make consistent,excess profits by purchasing stocks on the 20^th of the month and selling them on the last day of the month.If this is true,then:

Accepted Answer

If the pattern of purchasing stocks on the 20th of the month and selling them on the last day of the month consistently yields excess profits, then the market is not weak-form efficient, as this pattern would not be profitable if all available information were already incorporated into the price. Therefore, option B is the best choice. Option A is incorrect as the market is not semi-strong efficient if consistently profitable patterns exist. Option C is not necessarily true, as anyone who follows this pattern can potentially profit. Option D is irrelevant to the given scenario.

Question 18

A stock offers an expected dividend of $3.50,has a required return of 14%,and has historically exhibited a growth rate of 6%.Its current price is $35.00 and shows no tendency to change.How can you explain this price based on the constant growth dividend discount model?

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Question 19

Explain why the market value of common stock often differs from its liquidation value or its book value.

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Question 20

How can you reconcile the fact that whether an investor favors dividends or capital gains,the investor should accept the dividend discount model as a determination of share value?

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Quiz 7: Valuing Stocks