Question 1

Spacefood Products will pay a dividend of $2.40 per share 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

The current value of the stock can be calculated using the Gordon Growth Model (Dividend Discount Model): P = D / (r - g), where P is the price, D is the dividend, r is the required rate of return, and g is the growth rate. Plugging in the values: P = $2.40 / (0.10 - 0.03) = $34.29.

Question 2

Stocks that do not pay a dividend must have a value of $0.

Accepted Answer

Stocks that do not pay a dividend still have value based on their potential for growth and future earnings. The value of a stock is based on various factors such as market demand, earnings reports, and future growth prospects.

Question 3

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

11ea7fd1_1f64_bf76_99dd_b5af9db2b5ff_TB1622_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 4

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

The answer of Kirkevue Industries pays out all its earnings...

Question 5

Sultan Services has 1.2 million shares outstanding.It expects earnings at the end of the year of $5.6 million.Sultan pays out 60% of its earnings in total - 40% paid out as dividends and 20% used to repurchase shares.If Sultan's earnings are expected to grow by 7% per year,these payout rates do not change,and Sultan's equity cost of capital is 9%,what is Sultan's share price?

Accepted Answer

Firstly, we need to find out Sultan's after-tax earnings, which is:
$5.6 million * (1-0.4) = $3.36 million
Then, we need to deduct 20% of the after-tax earnings used for share repurchases:
$3.36 million * (1-0.2) = $2.688 million
Next, we need to find out Sultan's dividends per share:
Dividends per share = ($3.36 million * 0.4) / 1.2 million = $1.12 per share
Then, we can find out Sultan's share price using the Gordon growth model:
Share price = Dividends per share / (Cost of equity - Dividend growth rate)
The dividend growth rate is equal to the earnings growth rate multiplied by the payout rate:
Dividend growth rate = 7% * 0.4 = 2.8%
Substituting the values into the formula, we get:
Share price = $1.12 / (0.09 - 0.028) = $140.00
Therefore, the best choice is D.

Question 6

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 Sunnyfax's equity cost of capital,what is the expected share price as a consequence of this decision?

Accepted Answer

The expected share price can be calculated using the Gordon Growth Model. The new dividend is $2.00, and the growth rate is 12%. Assuming the equity cost of capital remains the same, the share price is calculated as $2.00 / (equity cost of capital - 0.12). Given the original dividend of $3.00 and share price of $38, the equity cost of capital is $3.00 / $38 = 0.0789 or 7.89%. The new share price is $2.00 / (0.0789 - 0.12) = $50.00.

Question 7

Which of the following is NOT a method by which a company can increase its dividend payments?

Accepted Answer

Issuing more shares would dilute the existing shares and decrease their value, making it harder for the company to pay higher dividends per share. Increasing earnings, decreasing the number of shares outstanding, and increasing the dividend payout rate are all viable methods for a company to increase its dividend payments.

Question 8

How can the dividend-discount model handle changing growth rates?

Accepted Answer

The answer of How can the dividend-discount model handle changing...

Question 9

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

The answer of JRN Enterprises just announced that it plans...

Question 10

Can the dividend-discount model handle negative growth rates?

Accepted Answer

The answer of Can the dividend-discount model handle negative growth...

Question 11

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

We can use the formula for calculating the present value of a growing perpetuity to find the current value of Avril's stock:

PV = D / (r - g)

where PV is the present value, D is the dividend, r is the equity cost of capital, and g is the expected growth rate of the dividend.

Substituting the given values, we get:

PV = 1.30 / (0.14 - 0.05) = 14.44

Therefore, the current value of a single share of Avril's stock is $14.44. The best choice is C).

Question 12

Forecasting dividends requires forecasting the firm's future earnings.

Accepted Answer

Dividends are usually paid out of a firm's earnings, so to forecast dividends, it is necessary to forecast the firm's future earnings.

Question 13

Sinclair Pharmaceuticals,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 Pharmaceuticals 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 Pharmaceuticals today?

Accepted Answer

To calculate the value of a share of Sinclair Pharmaceuticals, we need to use the dividend discount model (DDM). 
1. Calculate the earnings per share (EPS) for each of the next three years:
Year 1: $1.20 x 1.40 = $1.68
Year 2: $1.68 x 1.40 = $2.35
Year 3: $2.35 x 1.40 = $3.29
2. Calculate the expected dividends for year 4:
Expected earnings for year 4 = $3.29 x 1.05 = $3.45
Expected dividends for year 4 = $3.45 x 0.75 = $2.59
3. Calculate the present value of all expected dividends:
PV of all expected dividends = [($1.68 / 1.10) + ($2.35 / 1.10^2) + ($3.29 / 1.10^3) + ($2.59 / 1.10^4)]
= $1.53 + $1.83 + $2.30 + $1.73 = $7.39
4. Add the present value of all expected dividends to the expected value of the stock after four years:
Expected value of stock after four years = ($3.45 / 0.10) x 0.25 = $8.63
Total value of the share today = $7.39 + $8.63 = $16.02
Therefore, the correct answer is B) $38.96.

Question 14

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 15

Which of the following models can be used to value a firm without explicitly forecasting that firm's dividends,share repurchases,or its use of debt?
I.Dividend-discount model
II.Total payout model
III.Discounted free cash flow model

Accepted Answer

The discounted free cash flow model can be used to value a firm without explicitly forecasting its dividends, share repurchases, or its use of debt. The model calculates the present value of the firm's expected future free cash flows, which includes cash available for distribution to shareholders and debt holders after investments in the business have been made. The dividend-discount model and total payout model both require explicit forecasting of the firm's dividends or total payouts.

Question 16

Gremlin Industries will pay a dividend of $1.80 per share 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

The answer of Gremlin Industries will pay a dividend of...

Question 17

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

The correct answer is A.The expected annual growth rate of the company's dividends can be calculated using the Gordon Growth Model:Dividend Growth Rate = (Dividend Yield - Cost of Equity) / (1 - Dividend Payout Ratio)Dividend Yield = Dividend per Share / Stock Price = $2.50 / $42.00 = 5.95%Dividend Payout Ratio = Dividend per Share / Earnings per Share = $2.50 / $5.00 = 50%Therefore, Dividend Growth Rate = (5.95% - 8%) / (1 - 50%) = 2%

Question 18

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 Transport?

Accepted Answer

The answer of Jumbo Transport,an air-cargo company,expects to have earnings...

Question 19

What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?

Accepted Answer

The answer of What is the relationship between the growth...

Question 20

What is a major assumption about growth rate in the dividend-discount model?

Accepted Answer

The answer of What is a major assumption about growth...

Quiz 7: Stock Valuation