Question 1

Martian Airways Inc.has a 12% required rate of return.It does not expect to initiate dividends for 15 years,at which time it will pay $2.00 per share in dividends.At that time,Martian Airways expects its dividends to grow at 7% forever.What is an estimate of Martian Airways' price in 15 years (P15)if its dividend at the end of year 15 is $2.00?

Accepted Answer

The price in 15 years (P15) can be calculated using the Gordon Growth Model: P15 = D16 / (r - g) = $2.00 * (1 + 0.07) / (0.12 - 0.07) = $42.80.

Question 2

What if the company goes out of business in fifteen years and thus pays an annual dividend of $2.10 for only those fifteen years? What is the present value of a share for this company if we want a 10% return on the stock?

Accepted Answer

The present value of a share can be calculated using the formula for the present value of an annuity: PV = D * [(1 - (1 + r)^-n) / r], where D is the annual dividend, r is the required rate of return, and n is the number of years. Plugging in the values: PV = $2.10 * [(1 - (1 + 0.10)^-15) / 0.10] = $15.97.

Question 3

Which of the statements below is FALSE?

Accepted Answer

The statement that one unlikely dividend pattern is to raise or grow dividends by a fixed amount at fixed intervals is false. This is because in practice, companies rarely follow such a predictable dividend pattern. Instead, dividend payouts may vary depending on a variety of factors such as company performance, cash flow, and financial obligations.

Question 4

You buy a stock for which you expect to receive an annual dividend of $2.10 for the fifteen years that you plan on holding it.After 15 years,you expect to sell the stock for $32.25.What is the present value of a share for this company if you want a 10% return?

Accepted Answer

To calculate the present value of a stock, we need to use the formula PV = (dividend/interest rate) x (1 - 1/(1+interest rate)^n) + (selling price)/(1+interest rate)^n, where PV is the present value, dividend is the annual dividend, interest rate is the required rate of return, n is the number of years, and selling price is the expected selling price at the end of the holding period. Plugging in the given values, we get PV = (2.10/0.10) x (1 - 1/(1.10)^15) + (32.25)/(1.10)^15 = $23.69. Therefore, the best choice is C.

Question 5

Why would we want to assume a constant growth to dividends if we seldom see a firm with this type of pattern?

Accepted Answer

Assuming a constant growth rate to dividends allows us to estimate a series of future dividends, even if it is unlikely that a firm has a consistent growth pattern in reality. This assumption is necessary for calculating the present value of future dividend payments in financial analysis.

Question 6

In a stream of past dividends,the initial dividend is $0.75 and the most recent dividend is $1.25.The number of years between these two dividends (n)is 8 years.What is the average growth rate during this eight-year period? Use a calculator to determine your answer.

Accepted Answer

The answer of In a stream of past dividends,the initial...

Question 7

In applying the constant dividend model with infinite horizon to price a stock for purchase,we assume the company will pay dividends forever and that we will hold onto our stock forever.

Accepted Answer

The constant dividend model with infinite horizon assumes that the company will pay dividends forever and that the investor will hold onto their stock forever. This is why it is also known as the Gordon Growth Model.

Question 8

The dividend stream we would have legal claim to is for only that period of the company's life during which we own the stock or until the company goes out of business and stops paying dividends.

Accepted Answer

This is because the dividend payments are only applicable to the period of time during which the investor owns the stock. Once the investor sells the stock, they cease to be entitled to any further dividend payments from that company. Additionally, if the company goes out of business, they will also stop paying dividends.

Question 9

Plimpton Inc.just paid a dividend of $1.33.Its stock has a dividend growth rate of 7.6% and a required return of 12.21%.What is the current stock price if we anticipate dividends stopping in 10 years?

Accepted Answer

The answer of Plimpton Inc.just paid a dividend of $1.33.Its...

Question 10

If we believe that a company is following a constant dividend policy,we can then use the current dividend to predict all future dividends because they are the same.

Accepted Answer

If a company is following a constant dividend policy, then it is expected that future dividends will be equivalent to the current dividend. Therefore, we can use the current dividend as a basis to predict all future dividends.

Question 11

In a stream of past dividends,the initial dividend is $1.25 and the most recent dividend is $1.80.The number of years between these two dividends (n)is 7 years.What is the average growth rate during this seven-year period? Use a calculator to determine your answer.

Accepted Answer

To calculate the average growth rate, we use the formula: [(Most recent dividend/Initial dividend)^(1/n)-1]*100%. Plugging in the given values, we get [(1.8/1.25)^(1/7)-1]*100% = 5.35%. Therefore, the answer is choice B.

Question 12

The last dividend (Div0)is $1.80,the growth rate (g)is 6%,and the required rate of return (r)is 12%.What is the stock price according to the constant growth dividend model?

Accepted Answer

The constant growth dividend model is:Stock Price = Div0 * (1 + g) / (r - g)= 1.80 * (1 + 0.06) / (0.12 - 0.06)= 1.80 * 1.06 / 0.06= $30.80

Question 13

When estimating the annual growth rate of a dividend stream,we can use a short-cut to determining the average growth rate by ________.

Accepted Answer

To estimate the average growth rate of a dividend stream, it is best to use the first and last dividend in the stream along with the time-value of money equation. This method takes into consideration the growth of the dividend stream over the entire period and provides a more accurate estimation of the growth rate. Using just the first or last dividend may not provide an accurate estimate since it does not take into consideration the fluctuations in the dividend growth rate throughout the period. Using the future value interest factor is not appropriate for estimating dividend growth rates.

Question 14

Crosby Inc.has an 11% required rate of return.It does not expect to initiate dividends for 20 years,at which time it will pay $4.00 per share in dividends.At that time,Crosby expects its dividends to grow at 6% forever.What is an estimate of Crosby's price in 20 years (P20)if its dividend at the end of year 20 is $4.00?

Accepted Answer

Using the dividend discount model:
P20 = (D21 / (r - g))
Where D21 is the dividend in year 21 (since Crosby is not paying dividends for the first 20 years), r is the required rate of return, and g is the growth rate of dividends after year 20.
D21 = D20 * (1 + g) = $4.00 * (1 + 0.06) = $4.24
P20 = ($4.24 / (0.11 - 0.06)) = $84.80
Therefore, the estimate of Crosby's price in 20 years (P20) is $84.80.

Question 15

The next dividend (Div1)is $1.80,the growth rate (g)is 6%,and the required rate of return (r)is 12%.What is the stock price,according to the constant growth dividend model?

Accepted Answer

The answer of The next dividend (Div1)is $1.80,the growth rate...

Question 16

If we assume that a company will be in business forever and that it continues to pay dividends during its existence,then we have an annuity dividend stream.

Accepted Answer

An annuity involves payments of equal amounts at regular intervals for a specific period of time, whereas a dividend stream from a company assumed to be in business forever and paying dividends continuously would be considered a perpetuity, not an annuity, because it does not have a fixed end period.

Question 17

The Commuter Solutions Company just paid an annual dividend of $1.12.If you expect a constant growth rate of 4% and have a required rate of return of 13%,what is the current stock price according to the constant growth dividend model?

Accepted Answer

Using the constant growth dividend model: P = D/(r-g), where P is the current stock price, D is the dividend, r is the required rate of return, and g is the growth rate.

Plugging in the given values, we get:

P = $1.12/(0.13 - 0.04) = $1.12/0.09 = $12.44

So the closest answer choice is B) $12.94, which is the correct answer after rounding to the nearest cent.

Question 18

The constant growth dividend model requires that ________.

Accepted Answer

The constant growth dividend model assumes that the growth rate of the dividend stream is constant, and that the return rate (or required rate of return) is greater than the growth rate. This is because if the growth rate were to exceed the return rate, the stock would be considered overvalued and not worth investing in. Thus, the best choice is A, where the return rate r is greater than the growth rate g of the dividend stream.

Question 19

________ means that the percentage increase in the dividend is the same each year.

Accepted Answer

Constant growth means that the dividend increases by the same percentage each year, which is also known as a constant growth rate. This is commonly seen with mature companies that have predictable earnings and a consistent dividend policy.

Question 20

Korver Inc.just paid a dividend of $0.73.Its stock has a dividend growth rate of 5.62% and a required return of 10.21%.What is the current stock price if we anticipate dividends stopping in 20 years?

Accepted Answer

The stock price can be calculated using the dividend discount model for a finite period. The formula is P = D * [(1 - (1 + g)^n / (1 + r)^n) / (r - g)], where D is the dividend, g is the growth rate, r is the required return, and n is the number of years. Plugging in the values: P = 0.73 * [(1 - (1 + 0.0562)^20 / (1 + 0.1021)^20) / (0.1021 - 0.0562)] gives approximately $9.62.

Quiz 7: Stocks and Stock Valuation