Question 1

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

We can use the Gordon Growth Model to calculate the expected growth rate of KTI's dividends:

Expected Growth Rate = Retention Rate x Return on New Investments

Retention Rate = 1 - Dividend Payout Ratio = 1 - 1.50/3 = 0.50
Return on New Investments = 15%

Expected Growth Rate = 0.50 x 15% = 7.5%

Therefore, the closest answer choice is B (7.5%).

Question 2

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 3

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 because the expected annual growth rate of the company's dividends is 2%. This can be calculated using the Gordon Growth Model, which states that the expected annual growth rate of dividends is equal to the dividend yield minus the cost of equity. In this case, the dividend yield is $2.50/$42.00 = 5.95%, and the cost of equity is 8%. Therefore, the expected annual growth rate of dividends is 5.95% - 8% = 2%.

Question 4

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

We can use the Gordon Growth Model to calculate the expected growth rate in earnings.

G = (D / P) + g, where G is the required rate of return, D is the dividend, P is the current stock price, and g is the expected growth rate.

Plugging in the given information, we get:

14% = ($2.50 / $25.00) + g

Solving for g, we get:

g = 4%

Therefore, the expected growth rate in the Sisyphean Company's earnings is 4%.

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

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Question 6

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

Using the dividend discount model:
Previous price = D/(r-g) = 1.75/(0.05) = $35.00
New price= D/(r-g) = 1.00/(0.07) = $14.29
Thus, the stock price will decrease from $35.00 to $14.29 after the dividend cut.

Question 7

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

The dividend payout ratio is 50% ($1.50 / $3). The remaining 50% is assumed to be reinvested back into the company and earn a return of 15%. Using the Gordon growth model, we can calculate the value of KTI's stock as:

V = D / (r - g)
V = $1.5 / (0.12 - 0.075)
V = $33.33

Rounding to the nearest cent, the value of KTI's stock is closest to $33.35. Therefore, the best choice is C.

Question 8

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 VBC stock is closest to:

Accepted Answer

The correct answer is A because the value of a share of VBC stock is closest to $25.00. This is calculated using the dividend discount model, which takes into account the expected dividend, the growth rate of the dividend, and the equity cost of capital.

Question 9

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

The present value of Bean's stock can be calculated using the dividend discount model, with the assumption that the dividends will grow at a varying rate for the next five years and then remain constant.

The calculation can be broken down into three parts:

1) Calculating the present value of the dividends for years 1-3, using the formula:

PV = D/(1+r)^t

where PV is the present value, D is the dividend, r is the discount rate, and t is the time period.

In this case, the dividends for years 1-3 will be $2 each year, and the discount rate is 12%.

So:

PV1 = $2/(1+0.12)^1 = $1.79 
PV2 = $2/(1+0.12)^2 = $1.59 
PV3 = $2/(1+0.12)^3 = $1.42

2) Calculating the present value of the dividends for years 4-5, using the formula:

PV = D*(1+g)/(r-g)/(1+r)^t

where g is the growth rate of the dividend.

In this case, the dividends for years 4-5 will be 50% of the previous year's dividend, so:

D4 = $2*0.5 = $1.00 
D5 = $1.50*0.5 = $0.75

The growth rate can be calculated as:

g = (D5/D4)^(1/2) - 1 = (0.75/1)^0.5 - 1 = -0.22

(Note: a negative growth rate means that the dividend is decreasing from year to year.)

So:

PV4 = $1.00*(1-0.22)/(0.12-(-0.22))/(1+0.12)^4 = $1.02 
PV5 = $0.75*(1-0.22)/(0.12-(-0.22))/(1+0.12)^5 = $0.84

3) Calculating the present value of the dividends beyond year 5, using the formula:

PV = D/(r-g)/(1+r)^t

In this case, the dividends beyond year 5 will be 25% of the previous year's dividend (i.e. the growth rate is -75%), so:

D6 = $1.50*0.25 = $0.38 
D7 = $0.38*0.25 = $0.09 
D8+ = $0.09*1.20 = $0.11

So:

PV6+ = $0.38/(0.12-(-0.75))/(1+0.12)^6 + $0.09/(0.12-(-0.75))/(1+0.12)^7 + $0.11/(0.12-(-0.75))/(1+0.12)^8 = $1.01

Finally, the present value of the stock can be calculated by adding up the present values of all the dividends:

PV = PV1 + PV2 + PV3 + PV4 + PV5 + PV6+ = $6.17

Therefore, the price of a share of Bean's stock is closest to:

Price = PV = $27.75

Question 10

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 11

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

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Question 12

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 after the dividend cut and reinvestment can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a perpetuity) formula: P = D / (r - g), where P is the price of the stock, D is the dividend per share, r is the cost of equity, and g is the growth rate. Before the reinvestment, the cost of equity (r) can be calculated using the original dividend and share price: r = D / P + g, where D is $3.00, P is $38, and g is 0 because the company pays out all its earnings. However, since the company is now retaining some earnings, we focus on the new scenario where D is $2.00, and g is 12% (or 0.12). The cost of equity (r) remains unchanged as the reinvestment does not affect Sunnyfax's equity cost of capital. We use the original scenario to find r: r = 3 / 38 + 0 = 0.0789 or 7.89%. Using the new D and g in the formula gives us P = 2 / (0.0789 - 0.12), which is not directly solvable with the given information because we incorrectly calculated r without considering growth initially. Correcting the approach: Since the company pays out all its earnings initially, the growth rate (g) is 0, and the dividend yield plus growth rate gives us the cost of equity. After the dividend cut, the expected growth rate is 12%, but we need to find the cost of equity (r) correctly. The initial calculation of r was incorrect because it assumed a growth rate of 0 which was not needed for the initial r calculation. Given the dividend cut and reinvestment leading to growth, and without the exact cost of equity (r) provided or a way to calculate it directly from the given information (since the initial calculation of r was based on a misunderstanding), we focus on the growth impact. The correct approach involves understanding that the share price is expected to increase due to the reinvestment of funds at a higher growth rate than before, but without the exact r, we cannot directly calculate the new price using the formula provided in the explanation. The correct approach to find the new share price involves recognizing that the reduction in dividend and the subsequent reinvestment at a 12% growth rate would generally lead to an expectation of share price increase due to the value of future dividends increasing. However, without the precise cost of equity or a clear method to calculate it from the provided information, the calculation cannot be directly completed as initially attempted. The expectation of a share price increase is based on the principle that reinvesting at a higher rate of return (12% in this case) should increase the company's value, but the exact new share price requires additional information or assumptions not provided in the question.

Question 13

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

The answer of Kilbright Corporation stock is currently trading at...

Question 14

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

The answer of Sinclair ^{Pharmaceuticals},a small drug company,develops a vaccine...

Question 15

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

The current value of a single share of Spacefood's stock can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a perpetuity with growth). The formula is P = D / (r - g), where P is the price of the stock, D is the dividend at the end of the first year, r is the cost of equity, and g is the growth rate of the dividend. Plugging in the values given: P = $2.40 / (0.10 - 0.03) = $2.40 / 0.07 = $34.29.

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

The growth rate of Luther's dividends can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetually growing dividend), which is given by the formula: Cost of Equity = Dividend Yield + Growth Rate. Rearranging the formula to solve for the growth rate gives: Growth Rate = Cost of Equity - Dividend Yield. Plugging in the given numbers: Growth Rate = 12% - 4.5% = 7.5%.

Question 17

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

The current value of a stock with constant growth can be calculated using the Gordon Growth Model: P = D1 / (r - g), where D1 is the dividend next year ($1.30 * 1.05 = $1.365), r is the cost of equity (14% or 0.14), and g is the growth rate (5% or 0.05). Plugging in the values: P = $1.365 / (0.14 - 0.05) = $14.44.

Question 18

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

The answer of Adelaide Industries expects to have earnings per...

Question 19

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

The equity cost of capital can be calculated using the Gordon Growth Model (Dividend Discount Model): Cost of Equity = (Dividend per share / Current stock price) + Growth rate = ($1.80 / $22.40) + 0.04 = 0.08 + 0.04 = 0.12 or 12%.

Question 20

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

The answer of NoGrowth Industries presently pays an annual dividend...

Quiz 7: Valuing Stocks