Question 1

You are considering acquiring a common share of Sahali Shopping Center Corporation that you would like to hold for 1 year. You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year. The maximum price you would pay for a share today is ________ if you wanted to earn a 12% return.

Accepted Answer

V₀= 11eaaae8_8b4f_358a_a4b8_3d070e35ba74_TB6474_11 = 32.37

Question 2

A firm is planning on paying its first dividend of $2 three years from today. After that, dividends are expected to grow at 6% per year indefinitely. The stock's required return is 14%. What is the intrinsic value of a share today?

Accepted Answer

Intrinsic value at time 3 = $2*(1+0.06)/(0.14−0.06) = $26.50 plus $2 dividend paid in year 3 Intrinsic value today = $28.50/(1.14)³ =$19.24

Question 3

Suppose that in 2018 the expected dividends of the stocks in a broad market index equaled $240 million when the discount rate was 8% and the expected growth rate of the dividends equaled 6%. Using the constant-growth formula for valuation, if interest rates increase to 9%, the value of the market will change by ________.

Accepted Answer

Original value = 11eaaae8_8b4e_e767_a4b8_ed055e4f7c7d_TB6474_11 = 12,000 Million
New value = 11eaaae8_8b4e_e768_a4b8_c3bdbf7ec920_TB6474_11 = 8,000 Million
%△ = 11eaaae8_8b4f_0e79_a4b8_094b9e913fb3_TB6474_11 = -33.33%

Question 4

Rose Hill Trading Company is expected to have EPS in the upcoming year of $8. The expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its dividend in the upcoming year should be ________.

Accepted Answer

D₁ = $8 × (1 − 0.7) = $2.40

Question 5

The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12%, and its expected EPS is $5. If the firm's plowback ratio is 50%, its P/E ratio will be ________.

Accepted Answer

Dividend payout ratio = 1 − 0.5 = 0.5
Expected dividend = 0.5 × $5 = $2.50
Growth rate = 0.5 × 12% = 6%
Value = $2.50/(0.10 − 0.06) = $62.50
P/E = $62.50/$5 = 12.5

Question 6

You want to earn a return of 11% on each of two stocks, A and B. Stock A is expected to pay a dividend of $3 in the upcoming year, while stock B is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends for both stocks is 4%. Using the constant-growth DDM, the intrinsic value of stock A ________.

Accepted Answer

Using the constant-growth DDM, we can calculate the intrinsic value of each stock as follows:

For stock A: 
Intrinsic value = D1 / (r - g) 
= $3 x (1 + 0.04) / (0.11 - 0.04) 
= $34.29

For stock B: 
Intrinsic value = D1 / (r - g) 
= $2 x (1 + 0.04) / (0.11 - 0.04) 
= $22.86

Therefore, the intrinsic value of stock A is higher than the intrinsic value of stock B, meaning that stock A is the better choice if you want to earn a return of 11%.

Question 7

Flanders, Inc., has expected earnings of $4 per share for next year. The firm's ROE is 8%, and its earnings retention ratio is 40%. If the firm's market capitalization rate is 15%, what is the present value of its growth opportunities?

Accepted Answer

Value with no growth = $4/0.15 = $26.67
Growth rate = 0.4 × 8% = 3.2%
Value with growth = $4 × (1 − 0.4)/(0.15 − 0.032) = $20.34
PVGO = $20.34 − 26.67 = −$6.33

Question 8

Eagle Brand Arrowheads has expected earnings of $1.25 per share and a market capitalization rate of 12%. Earnings are expected to grow at 5% per year indefinitely. The firm has a 40% plowback ratio. By how much does the firm's ROE exceed the market capitalization rate?

Accepted Answer

ROE = g/b = 0.05/0.4 = 12.5%; k is given as 12%, so ROE − k = 0.5%

Question 9

Brevik Builders has an expected ROE of 25%. Its dividend growth rate will be ________ if it follows a policy of paying 30% of earnings in the form of dividends.

Accepted Answer

g = 0.25(1 − 0.3) = 0.175

Question 10

Gagliardi Way Corporation has an expected ROE of 15%. If it pays out 30% of its earnings as dividends, its dividend growth rate will be ________.

Accepted Answer

b = 1 − 0.3 = 0.7
g = b × ROE = 0.7 × 15% = 10.5%

Question 11

Rose Hill Trading Company is expected to have EPS in the upcoming year of $6. The expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its intrinsic value should be ________.

Accepted Answer

V₀= 11eaaae8_8b4f_aabd_a4b8_c745e8d431d6_TB6474_11 = 128.57

Question 12

The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12%, and its expected EPS is $5. If the firm's plowback ratio is 60%, its P/E ratio will be ________.

Accepted Answer

Dividend payout ratio = 1 − 0.46 = 0.4
Expected dividend = 0.4 × $5 = $2
Growth rate = 0.6 × 12% = 7.2%
Value = $2/(0.1 − 0.072) = $71.43
P/E = $71.43/$5 = 14.29

Question 13

A preferred share of Coquihalla Corporation will pay a dividend of $8 in the upcoming year and every year thereafter; that is, dividends are not expected to grow. You require a return of 7% on this stock. Using the constant-growth DDM to calculate the intrinsic value, a preferred share of Coquihalla Corporation is worth ________.

Accepted Answer

V₀= 11eaaae8_8b4f_83ac_a4b8_f16222d3cf8b_TB6474_11 = 114.29

Question 14

Ace Ventura, Inc., has expected earnings of $5 per share for next year. The firm's ROE is 15%, and its earnings retention ratio is 40%. If the firm's market capitalization rate is 10%, what is the present value of its growth opportunities?

Accepted Answer

Value with no growth = $5/0.10 = $50
Growth rate = 0.4 × 15% = 6%
Value with growth = $5 × (1 − 0.4)/(0.10 − 0.06) = $75
PVGO = $75 − 50 = $25

Question 15

Grott and Perrin, Inc., has expected earnings of $3 per share for next year. The firm's ROE is 20%, and its earnings retention ratio is 70%. If the firm's market capitalization rate is 15%, what is the present value of its growth opportunities?

Accepted Answer

Value with no growth = $3/0.15 = $20
Growth rate = 0.7 × 20% = 14%
Value with growth = $3 × (1 − 0.7)/(0.15 − 0.14) = $90
PVGO = $90 − 20 = $70

Question 16

Weyerhaeuser Incorporated has a balance sheet that lists $70 million in assets, $45 million in liabilities, and $25 million in common shareholders' equity. It has 1 million common shares outstanding. The replacement cost of its assets is $85 million. Its share price in the market is $49. Its book value per share is ________.

Accepted Answer

BVPS = 11eaaae8_8b4f_5c9b_a4b8_11fcbc11619c_TB6474_11 = 25.00

Question 17

You want to earn a return of 10% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5% for stock B. Using the constant-growth DDM, the intrinsic value of stock A ________.

Accepted Answer

Using the constant-growth DDM, we can calculate the intrinsic value of each stock using the formula:

Intrinsic Value = D / (r - g)

Where:
D = expected dividend = $4
r = required rate of return = 10% = 0.10
g = expected growth rate of dividends

For Stock A:
Intrinsic Value = $4 / (0.10 - 0.06) = $100

For Stock B:
Intrinsic Value = $4 / (0.10 - 0.05) = $80

Therefore, the intrinsic value of Stock A is higher than that of Stock B, and the best answer is A.

Question 18

Each of two stocks, A and B, is expected to pay a dividend of $7 in the upcoming year. The expected growth rate of dividends is 6% for both stocks. You require a return of 10% on stock A and a return of 12% on stock B. Using the constant-growth DDM, the intrinsic value of stock A ________.

Accepted Answer

Using the constant-growth DDM, the intrinsic value can be calculated as follows: 
For stock A:
Intrinsic value = Dividend / (Required rate of return - Dividend growth rate)
= $7 / (10% - 6%)
= $175
For stock B:
Intrinsic value = Dividend / (Required rate of return - Dividend growth rate)
= $7 / (12% - 6%)
= $116.67
Therefore, the intrinsic value of stock A is higher than the intrinsic value of stock B, so the answer is A.

Question 19

Annie's Donut Shops, Inc., has expected earnings of $3 per share for next year. The firm's ROE is 18%, and its earnings retention ratio is 60%. If the firm's market capitalization rate is 12%, what is the value of the firm excluding any growth opportunities?

Accepted Answer

Value with no growth = $3/0.12 = $25

Question 20

Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year. Dividends are expected to grow at 8% per year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate and use the constant-growth DDM to determine the value of the stock. The stock's current price is $84. Using the constant-growth DDM, the market capitalization rate is ________.

Accepted Answer

From the relationship k = (3.36/84) + 0.08 = 0.12

Quiz 13: Equity Valuation