Fundamentals of Investments Bradford Jordan 8e - Test Bank

Fundamentals of Investments Bradford Jordan 8e – Test Bank

 

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Sample Questions Are Posted Below

 

Fundamentals of Investments, 8e (Jordan)

Chapter 6   Common Stock Valuation

 

1) Which one of the following terms is used to identify the evaluation method that determines the value of a stock by reviewing a firm’s financial statement in conjunction with other financial and economic information?

1. A) technical analysis
2. B) conceptual analysis
3. C) prediction valuation
4. D) fundamental analysis
5. E) discounted valuation

 

Answer:  D

Explanation:  See Section 6.1

Difficulty: 1 Easy

Section:  6.1 Security Analysis: Be Careful Out There

Topic:  Fundamental analysis

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

2) The method of valuing a stock based on the present value of the future income derived from that stock is called:

1. A) technical analysis.
2. B) constant valuation.
3. C) the basic stock valuation method.
4. D) compound dividend analysis.
5. E) the dividend discount model.

 

Answer:  E

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

3) The model used to value a stock that pays a dividend which increases at a constant rate forever is referred to as which one of the following? Assume the growth rate is less than the discount rate.

1. A) diminishing valuation growth model
2. B) increasing valuation growth model
3. C) constant perpetual growth model
4. D) irregular growth perpetual model
5. E) two-stage growth model

 

Answer:  C

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

4) How is a sustainable dividend growth rate defined?

1. A) a constant rate at which dividends increase
2. B) a rate of growth that does not exceed two percent of the annual increase in revenue
3. C) a rate of growth that is set equal to one-half of the average growth rate of a firm’s earnings
4. D) a rate that can be supported over time by a company’s earnings
5. E) a rate of dividend growth that is equal to the discount rate used to value the firm’s stock

 

Answer:  D

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

5) The portion of net income that is held by a firm, for future growth, comprises which one of the following balance sheet accounts?

1. A) capital surplus
2. B) common stock
3. C) internal earnings
4. D) retained earnings
5. E) net earnings

 

Answer:  D

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Financial statements

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

6) What is the percentage of a firm’s earnings that is distributed to shareholders called?

1. A) payout ratio
2. B) distribution percentage
3. C) retention ratio
4. D) dividend portion
5. E) outflow ratio

 

Answer:  A

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividends and payout policy

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

7) What is the percentage of a firm’s net income which is reinvested in the firm to support future growth called?

1. A) payout ratio
2. B) distribution percentage
3. C) retention ratio
4. D) equity ratio
5. E) equity reinvestment

 

Answer:  C

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividends and payout policy

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

8) The model used to value the stock of a firm which has a short-term growth rate that varies from its long-term growth rate is called the ________ dividend growth model.

1. A) flexible
2. B) increasing
3. C) two-stage
4. D) stepped up
5. E) geometric

 

Answer:  C

Explanation:  See Section 6.3

Difficulty: 1 Easy

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

9) What is beta?

1. A) a rate of return measure
2. B) the return on a stock relative to the overall market
3. C) the rate of dividend growth
4. D) the percentage of net income paid out as a dividend
5. E) measure of a stock’s risk relative to the stock market average

 

Answer:  E

Explanation:  See Section 6.3

Difficulty: 1 Easy

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Beta

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

10) What is the accounting relationship in which earnings per share minus dividends equal the change in book value per share called?

1. A) clean surplus relationship
2. B) economic value added relationship
3. C) accounting earnings identity
4. D) payout-retention identity
5. E) dividend valuation equation

 

Answer:  A

Explanation:  See Section 6.4

Difficulty: 1 Easy

Section:  6.4 The Residual Income Model

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

11) The Free Cash Flow Model:

 

1. can be used to value a company with negative earnings.
2. is based on a firm having positive cash flows.

III. requires that a firm pay a dividend.

1. directly estimates a value for a firm’s equity

 

1. A) I only
2. B) I and II only
3. C) I and III only
4. D) I, II, and III only
5. E) I, II, III, and IV

 

Answer:  B

Explanation:  See Section 6.4

Difficulty: 1 Easy

Section:  6.4 The Residual Income Model

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

12) What is the market value of a share of stock divided by the net income per share called?

1. A) earnings per share
2. B) price-earnings ratio
3. C) value-earnings ratio
4. D) earnings yield
5. E) market multiple

 

Answer:  B

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

13) The net income per share divided by the market price per share is called the:

1. A) profit margin.
2. B) profit yield.
3. C) market yield.
4. D) earnings yield.
5. E) income ratio.

 

Answer:  D

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

14) Growth stocks are frequently described as having which one of the following characteristics?

1. A) high dividends
2. B) a value orientation
3. C) high P/E ratios
4. D) low cash flows per share
5. E) low retention ratios

 

Answer:  C

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

15) The price-book ratio is computed as the market value per share divided by the per share book value of:

1. A) total assets.
2. B) long-term debt.
3. C) equity.
4. D) long-term debt plus equity.
5. E) net working capital.

 

Answer:  C

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

16) A firm’s current stock price divided by the firm’s revenue per share is referred to as which one of the following ratios?

1. A) price-earnings
2. B) price-book
3. C) price-income
4. D) price-sales
5. E) price-cash flow

 

Answer:  D

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

17) An analysis of which of the following are commonly included as part of fundamental analysis?

 

1. sales
2. book value

III. earnings per share

1. cash flow

 

1. A) I and II only
2. B) I and IV only
3. C) II, III, and IV only
4. D) I, II, and IV only
5. E) I, II, III, and IV

 

Answer:  E

Explanation:  See Section 6.1

Difficulty: 1 Easy

Section:  6.1 Security Analysis: Be Careful Out There

Topic:  Fundamental analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

18) Based on the dividend discount model, an increase in which of the following will lower the current value of a stock?

 

1. amount of the next dividend
2. dividend growth rate

III. discount rate

 

1. A) I only
2. B) III only
3. C) I and II only
4. D) II and III only
5. E) I, II, and III

 

Answer:  B

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

19) The dividend discount model assumes that:

1. A) the dividend payout ratio will remain constant.
2. B) the dividend growth rate is equal to the discount rate.
3. C) discount rate increases at a constant rate.
4. D) at least one dividend will be paid in the future.
5. E) the dividend payout ratio increases at a constant rate.

 

Answer:  D

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

20) The constant perpetual growth model assumes the:

1. A) dividends are paid for a stated number of years only.
2. B) net income is all paid out in dividends.
3. C) growth rate is less than the discount rate.
4. D) dividends are constant in amount.
5. E) discount rate increases at a constant rate.

 

Answer:  C

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

21) The constant perpetual growth model is applicable primarily to those firms which:

1. A) adhere to a residual dividend policy.
2. B) pay dividends that increase at a steady rate.
3. C) have irregular dividend growth rates.
4. D) maintain a constant dividend payout ratio.
5. E) have multiple rates of dividend growth.

 

Answer:  B

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

22) Which one of the following is a correct formula for computing a geometric average dividend growth rate?

1. A) [(1 + D0) + (1 + D1) × (1 + DN)]N + 1- 1
2. B) [(1 + D0) × (1 + D1) × (1 + DN)]N – 1- 1
3. C) [DN/D0]1/N- 1
4. D) [D0/DN]N- 1
5. E) [DN/D0]N/1- 1

 

Answer:  C

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

23) The arithmetic average dividend growth rate is:

1. A) the compounded rate of growth over a specified time period.
2. B) easier to compute than the geometric average dividend growth rate.
3. C) the summation of the annual dividend growth rates.
4. D) generally preferred over the geometric average growth rate by most financial analysts.
5. E) generally larger than the geometric average growth rate when the annual growth rates are positive.

 

Answer:  E

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

24) The retention ratio is the:

1. A) net income divided by total equity.
2. B) percentage of net income paid out to shareholders.
3. C) net income divided by the number of shares outstanding.
4. D) percentage of net income held by a firm for future growth.
5. E) inverse of the dividend payout ratio.

 

Answer:  D

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

25) An increase in the retention ratio will:

1. A) increase the dividends per share.
2. B) decrease a firm’s sustainable rate of growth.
3. C) decrease the equity of a firm.
4. D) increase the dividend growth rate.
5. E) increase the value of a firm’s stock.

 

Answer:  E

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

26) A decrease in which one of the following will increase a firm’s sustainable rate of growth?

1. A) net income
2. B) dividend payout ratio
3. C) total assets
4. D) retention ratio
5. E) earnings per share

 

Answer:  B

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

27) The sustainable growth rate is equal to:

1. A) ROE × (1 – Payout ratio).
2. B) ROA × (1 – Payout ratio).
3. C) ROE × (1 – Retention ratio).
4. D) ROA × (1 – Retention ratio).
5. E) ROE × ROA.

 

Answer:  A

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

28) Hypo Tech expects its net income to grow at 20 percent a year for the next two years and then taper off to a constant 5 percent annual rate of growth. The firm maintains a constant dividend payout ratio. Which one of the following models is best suited for computing the current value of this firm’s stock?

1. A) irregular dividend
2. B) constant perpetual growth
3. C) constant dividend
4. D) two-stage dividend growth
5. E) perpetuity formula

 

Answer:  D

Explanation:  See Section 6.3

Difficulty: 1 Easy

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

 

29) Which one of the following is a requirement of the two-stage dividend growth model?

1. A) both growth rates must be less than the discount rate
2. B) one of the two growth rates must exceed the discount rate
3. C) the first growth rate must exceed the second growth rate
4. D) the first growth rate must equal the discount rate
5. E) the second growth rate must be less than the discount rate

 

Answer:  E

Explanation:  See Section 6.3

Difficulty: 1 Easy

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

30) Which one of the following statements concerning beta is correct?

1. A) The beta assigned to the overall market is zero.
2. B) A stock with a beta of 1.2 earns a higher risk premium than a stock with a beta of 1.3.
3. C) A stock with a beta of 0.5 has 50 percent more risk than the overall market.
4. D) Beta is applied to the T-bill rate when computing the discount rate used for the dividend discount models.
5. E) The higher the beta, the higher the discount rate used for the dividend discount models.

 

Answer:  E

Explanation:  See Section 6.3

Difficulty: 1 Easy

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Beta

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

 

31) Which one of the following is correct concerning the two-stage dividend growth model?

1. A) The discount rate is based on the coupon rate a firm pays on its outstanding bonds.
2. B) The first growth rate must be higher than the second growth rate.
3. C) The time value of money is ignored.
4. D) The discount rate ignores the risks associated with an individual firm.
5. E) The discount rate considers the risk-free rate of return.

 

Answer:  E

Explanation:  See Section 6.3

Difficulty: 1 Easy

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

32) How will the price of a stock be affected if the dividend growth rate is decreased?

1. A) increase
2. B) either increase or no change
3. C) no change
4. D) either decrease or no change
5. E) decrease

 

Answer:  E

Explanation:  See Section 6.2

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

33) Which one of the following will increase the current residual income of a firm?

1. A) an increase in required earnings
2. B) a decrease in the current earnings per share
3. C) a decrease in future earnings per share
4. D) a decrease in the required return on the firm’s equity
5. E) an increase in the firm’s beginning book equity per share

 

Answer:  D

Explanation:  See Section 6.4

Difficulty: 1 Easy

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

34) Which one of the following models can be used to value the stock of a firm that maintains a one hundred percent retention ratio?

1. A) two-stage growth
2. B) residual income
3. C) perpetual dividend growth
4. D) supernormal growth
5. E) perpetual cash flow

 

Answer:  B

Explanation:  See Section 6.4

Difficulty: 1 Easy

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

35) Which of the following have the same meaning as the term “economic value added”?

 

1. abnormal earnings
2. residual income

III. value created by a firm in period t

1. EPSt – Bt-1× k
2. A) I and II only
3. B) III and IV only
4. C) I, II, and III only
5. D) II, III, and IV only
6. E) I, II, III, and IV

 

Answer:  E

Explanation:  See Section 6.4

Difficulty: 1 Easy

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

36) Which one of the following correctly expresses the clean surplus relationship?

1. A) The change in book value per share is equal to earnings per share minus dividends.
2. B) The change in retained earnings is equal to net income.
3. C) The change in market value per share is equal to the change in book value per share.
4. D) The change in market value per share is equal to earnings per share minus dividends.
5. E) The rate of change in book value per share is equal to the firm’s discount rate.

 

Answer:  A

Explanation:  See Section 6.4

Difficulty: 1 Easy

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

37) Which one of the following statements related to the price-earnings (P/E) ratio is correct?

1. A) The earnings yield is the inverse of the P/E ratio.
2. B) The P/E ratio is equal to the market price per share divided by total net income.
3. C) The P/E ratio shown in The Wall Street Journal is based on next year’s estimated earnings per share.
4. D) The P/E ratio varies directly with earnings per share.
5. E) The earnings for the past twelve months is the method analysts prefer for computing earnings for the P/E ratio.

 

Answer:  A

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Price-earnings ratio

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

38) Which one of the following is used as an indicator that a firm has good-quality earnings?

1. A) declining price-earnings ratios
2. B) constant price-earnings ratios
3. C) cash flow per share that exceeds earnings per share
4. D) earnings per share that exceed cash flow per share
5. E) positive earnings per share

 

Answer:  C

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Per-share valuations

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

39) Which one of the following is the most common definition of cash flow as used in the price-cash flow ratio?

1. A) net income minus dividends
2. B) net income plus depreciation
3. C) net income minus depreciation plus taxes
4. D) earnings before interest and taxes plus depreciation
5. E) earnings before interest and taxes

 

Answer:  B

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

40) The price-sales ratio helps measure the ability of a firm to generate:

1. A) net profits.
2. B) quality cash flows.
3. C) higher earnings per share.
4. D) higher cash flow per share.
5. E) revenue growth.

 

Answer:  E

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

41) You would like to know the value of a firm’s equity today in relation to the cost of that equity. Which one of the following ratios will provide you with this information?

1. A) price-earnings
2. B) price-book
3. C) price-sales
4. D) price-cash flow
5. E) price-assets

 

Answer:  B

Explanation:  See Section 6.6

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 1 Remember

Accessibility:  Keyboard Navigation

 

 

42) America Boats plans to pay a $2.10 a share dividend at the end of each of the next 2 years. At the end of year 3, it will pay a final liquidating dividend of $13 a share. After that, the company plans to close its doors permanently. What is the current value of this stock at a discount rate of 12 percent?

9. A) $9.89
10. B) $10.26
11. C) $11.54
12. D) $12.80
13. E) $13.50

 

Answer:  D

Explanation:

p0	=	$2.10	+	$2.10	+	$13	=	$12.80
		(1.12)1		(1.12)2		(1.15)3

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

43) Upwind Tours just announced that it will pay an annual dividend of $3.60 a share one year from now. Two years from now, the company expects to pay a $28 a share liquidating dividend. After that, the company will cease operations. What is the current value per share at a discount rate of 12.5 percent?

23. A) $23.88
24. B) $24.97
25. C) $25.32
26. D) $28.09
27. E) $29.16

 

Answer:  C

Explanation:

p0	=	$3.60	+	$28	=	$25.32
		(1 + 0.125)1		(1 + 0.125)2

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

44) Lakeside Sheet Metal is downsizing and plans on completely closing 3 years from now. The firm’s liquidation plan calls for annual dividends of $3, $6, and $36 over the next 3 years, respectively. What is the current value of this stock given a discount rate of 14 percent?

26. A) $26.94
27. B) $27.16
28. C) $28.46
29. D) $31.50
30. E) $36.29

 

Answer:  D

Explanation:

p0	=	$3.00	+	$6.00	+	$36.00	=	$31.50
		(1 + 0.14)1		(1 + 0.14)2		(1 + 0.14)3

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

45) Alpha Wood Interiors announced today that it is going out of business. As of today, no more regular dividends will be paid. The firm will, however, pay two liquidating dividends. The first will be paid one year from now in the amount of $15 a share. The second and final payment will be paid two years from now at an estimated $40 a share. What is the value of this stock today at a discount rate of 16 percent?

38. A) $38.76
39. B) $39.03
40. C) $41.41
41. D) $42.66
42. E) $44.01

 

Answer:  D

Explanation:

p0	=	$15	+	$40	=	$42.66
		(1.16)1		(1.16)2

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

46) Blue Water Tours just paid an annual dividend of $0.80 a share. The firm has a policy of increasing the dividend by 3.5 percent annually. What is the current value of this stock at a discount rate of 11.5 percent?

9. A) $9.52
10. B) $9.78
11. C) $9.91
12. D) $10.02
13. E) $10.35

 

Answer:  E

Explanation:

p0	=	0.80(1.035)	=	$10.35
		0.115 − 0.35

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

47) Precision Engineering recently announced that its next annual dividend will be $1.20 per share with later dividends increasing by 2.5 percent annually. What is the current value of this stock to you if you require a 12 percent rate of return?

12. A) $12.63
13. B) $12.95
14. C) $13.05
15. D) $13.37
16. E) $13.72

 

Answer:  A

Explanation:

p0	=	$1.20	=	$12.63
		0.12 − 0.025

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

48) The Barclay House increases its dividend each year. The next annual dividend is expected to be $1.75 a share. Future dividends will increase by 4 percent annually. What is the current value of this stock if the discount rate is 10 percent?

28. A) $28.91
29. B) $28.05
30. C) $28.78
31. D) $29.00
32. E) $29.17

 

Answer:  E

Explanation:

p0	=	$1.75	=	$29.17
		0.10 + 0.04

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

49) Long Life Floors just paid an annual dividend of $0.82 a share and plans on increasing future dividends by 2 percent annually. The discount rate is 15 percent. What will the value of this stock be 5 years from today?

6. A) $6.96
7. B) $7.04
8. C) $7.10
9. D) $7.18
10. E) $7.25

 

Answer:  C

Explanation:

p5	=	$0.82(1.02)6	=	$7.10
		0.15 − 0.02

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

50) Wilson’s Furniture is experiencing good growth so has decided to commence paying dividends starting next year. The first dividend will be $0.50 a share with annual increases of 4 percent in the dividend amount. The discount rate is 10 percent. What will the value of this stock be four years from now?

8. A) $8.50
9. B) $8.72
10. C) $9.03
11. D) $9.23
12. E) $9.75

 

Answer:  E

Explanation:

p4	=	$0.50(1.04)4	=	$9.749
		0.10 − 0.04

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

51) The Back Room just paid an annual dividend of $1.50 a share. The firm expects to pay dividends forever and to increase the dividend by 4.5 percent annually. What is the expected value of this stock six years from now if the discount rate is 12 percent?

27. A) $27.22
28. B) $27.91
29. C) $28.06
30. D) $28.52
31. E) $29.08

 

Answer:  A

Explanation:

p6	=	$1.50(1.045)7	=	$27.22
		(0.12 − 0.045)

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

52) Main Street Antiques is planning on paying an annual dividend of $2.20 per share next year. The company is slowly downsizing and is decreasing its dividend by 3 percent annually. What is the current value of this stock at a discount rate of 8 percent?

18. A) $18.86
19. B) $19.12
20. C) $19.78
21. D) $20.00
22. E) $20.57

 

Answer:  D

Explanation:

p0	=	$2.20(1 + (−0.03))	=	$20.00
		0.08 − (−0.03)

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

53) You are considering buying shares of stock in the Steel Mill. The forecast for the firm is steady growth over the next decade. The firm just paid its annual dividend of $1.42 per share and has plans to increase that amount by 4 percent annually indefinitely. You require a 12.5 percent return on this type of security. What is your estimate of the value of this stock ten years from now?

24. A) $24.13
25. B) $24.38
26. C) $24.73
27. D) $25.06
28. E) $25.72

 

Answer:  E

Explanation:

p10	=	$1.42(1.04)11	=	$25.72
		0.125 − 0.04

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

54) BP Industries stock is valued at $11.50 a share. The firm pays annual dividends at an increasing rate of 3.0 percent annually. Next year’s dividend will be $1.15 per share. What is the required return on this stock?

10. A) 10.00 percent
11. B) 11.50 percent
12. C) 12.60 percent
13. D) 13.00 percent
14. E) 14.80 percent

 

Answer:  E

Explanation:

r	=	D1	+	g =	$1.15	+	0.30	= 13.00%
		P0			$11.50

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

55) Wholesale Foods common stock is valued at $11.05 per share. The firm pays annual dividends which increase at a constant rate. The last dividend paid was $1.20. The required return is 12 percent. What is the dividend growth rate?

1. A) 1.03 percent
2. B) 1.67 percent
3. C) 3.47 percent
4. D) 3.59 percent
5. E) 4.00 percent

 

Answer:  A

Explanation:

$11.05	=	$1.20(1 + g )	; g = 1.03 percent
		0.12 − g

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

56) A stock sells for $12.36 a share and has a required return of 9 percent. Dividends are paid annually and increase at a constant 3 percent per year. What is the amount of the last dividend paid?

1. A) $0.46
2. B) $0.50
3. C) $0.59
4. D) $0.63
5. E) $0.72

 

Answer:  E

Explanation:

$12.36	=	D0(1 + 0.30 )	; D0	=	$0.72
		0.09 + 0.30

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

57) Factory Stores pays annual dividends and increases those dividends by 3 percent each year. The stock is currently valued at $11.80 a share and has a required return of 14 percent. You own 500 shares of this stock. What is the total amount of dividend income you should expect to receive next year?

1. A) $649
2. B) $659
3. C) $672
4. D) $685
5. E) $699

 

Answer:  A

Explanation:  D(1) = P0(r − g) = $11.80(0.14 − 0.30) = $1.30

 

Dividend income  = $1.30 × 500 = $649

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

58) The common stock of JL Recyclers has a required return of 12 percent and a current value of $18.72. The company pays its dividend annually and increases the amount by 4 percent each year. You own 300 shares of this stock. What was the total amount of the last dividend you received?

1. A) $319
2. B) $360
3. C) $432
4. D) $480
5. E) $513

 

Answer:  C

Explanation:

$18.72	=	D0(1 + 0.40)	; D0	=	$1.44;
		0.12 + 0.40

 

Last total dividend = $1.44 × 300 = $432

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

59) The Rug Barn has paid annual dividends of $1.30, $1.36, $1.40, $1.42, and $1.45 over the last 5 years, respectively. What is the geometric average dividend growth rate?

1. A) 1.98 percent
2. B) 2.11 percent
3. C) 2.39 percent
4. D) 2.55 percent
5. E) 2.77 percent

 

Answer:  E

Explanation:

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

60) A firm has paid annual dividends of $1.34, $1.43, $1.55, $1.62, $1.64, and $1.75 per share over the past 6 years, respectively. What is the geometric average growth rate for these dividends?

5. A) 5.19 percent
6. B) 5.28 percent
7. C) 5.48 percent
8. D) 5.57 percent
9. E) 5.74 percent

 

Answer:  C

Explanation:

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

61) Over the past 5 years, DL Insulation has paid annual dividends of $1.40, $1.55, $1.70, $1.73, and $1.77 per share. What is the geometric average dividend growth rate for this period?

4. A) 4.80 percent
5. B) 5.79 percent
6. C) 5.88 percent
7. D) 6.04 percent
8. E) 6.33 percent

 

Answer:  D

Explanation:

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

62) The Brown Jug has paid annual dividends of $0.61, $0.64, $0.71, $0.82, and $0.88 per share over the past 5 years, respectively. What is the geometric average dividend growth rate for this period?

8. A) 8.51 percent
9. B) 8.97 percent
10. C) 9.10 percent
11. D) 9.59 percent
12. E) 10.21 percent

 

Answer:  D

Explanation:

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

63) Dennison Mfg. pays annual dividends. For the past six years, the firm has paid dividends of $1.10, $1.15 $1.20, $1.25, $1.30, and $1.35, respectively. What is the geometric average dividend growth rate for this time period?

3. A) 3.51 percent
4. B) 4.18 percent
5. C) 4.94 percent
6. D) 5.07 percent
7. E) 6.03 percent

 

Answer:  B

Explanation:

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

64) Over the past 4 years, a local firm has paid annual dividends of $1.52, $1.55, $1.60, and $1.68. What is the arithmetic average dividend growth rate?

2. A) 2.69 percent
3. B) 2.98 percent
4. C) 3.24 percent
5. D) 3.40 percent
6. E) 3.62 percent

 

Answer:  D

Explanation:

Annual growth Year 1-Year 2 =		1.97	%
Annual growth Year 2-Year 3 =		3.23	%
Annual growth Year 3-Year 4 =		5.00	%
Average annual growth rate =		3.40	%

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

65) Blue Water Tours has paid annual dividends of $2.10, $2.12, $2.15, $2.15, and $2.22 over the past 5 years, respectively. What is the arithmetic average growth rate for these dividends?

1. A) 1.08 percent
2. B) 1.41 percent
3. C) 1.57 percent
4. D) 1.70 percent
5. E) 1.73 percent

 

Answer:  B

Explanation:  Annual growth rate year 1 to 2: ($2.12 − $2.10) / $2.10 = 0.0095238

 

Annual growth rate year 2 to 3: ($2.15 − $2.12) / $2.12 = 0.0141509

 

Annual growth rate year 3 to 4: ($2.15 − $2.15) / $2.15 = 0.0000000

 

Annual growth rate year 4 to 5: ($2.22 − $2.15) / $2.15 = 0.0325581

 

Arithmetic average growth rate = (0.0095238 + 0.0141509 + 0 .00 + 0.0325581 / 4) = 1.41 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

66) Knit ‘n Needle started paying dividends 4 years ago. The annual dividends thus far have been $0.35, $0.38, $0.42, and $0.48, respectively. What is the arithmetic average dividend growth rate?

6. A) 6.33 percent
7. B) 8.58 percent
8. C) 9.70 percent
9. D) 10.80 percent
10. E) 11.13 percent

 

Answer:  E

Explanation:

Dividends	Growth rate
$0.35
$0.38		8.57	%
$0.42		10.53	%
$0.48		14.29	%
		11.13	%

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

67) Roy’s Markets has net income of $164,000. The firm has 200,000 shares of common stock outstanding. The dividend for this year is $0.61 per share. What is the retention ratio?

1. A) 0.220
2. B) 0.256
3. C) 0.314
4. D) 0.774
5. E) 0.780

 

Answer:  B

Explanation:  Retention ratio = [$164,000 − (200,000 × $.61)] / $164,000 = 0.256

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividends and payout policy

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

68) Detroit Imports has a dividend payout ratio of 40 percent and annual dividends of $2.60 per share. What is the retention ratio?

1. A) 0.167
2. B) 0.208
3. C) 0.600
4. D) 0.735
5. E) 0.792

 

Answer:  C

Explanation:  Retention ratio = 1 − 0.40 = 0.60

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividends and payout policy

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

69) Home Interiors has net income of $258,000. The firm has decided to pay $140,000 of that income out to the shareholders. What is the firm’s retention ratio?

1. A) 0.355
2. B) 0.412
3. C) 0.457
4. D) 0.588
5. E) 0.645

 

Answer:  C

Explanation:  Retention ratio = ($258,000 − $140,000) / $258,000 = 0.457

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividends and payout policy

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

70) Art Supplies has a net income of $138,600. The firm has $1.25 million in assets and $500,000 in liabilities. What is the return on equity?

13. A) 13.87 percent
14. B) 15.09 percent
15. C) 16.44 percent
16. D) 18.48 percent
17. E) 21.21 percent

 

Answer:  D

Explanation:  Return on equity = $138,500 / ($1,250,000 − $500,000) = 18.48 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Ratio analysis

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

71) Oak Supply has earnings per share of $1.22. The firm has $840,000 in equity and 60,000 shares of stock outstanding. What is the return on equity?

7. A) 7.92 percent
8. B) 8.71 percent
9. C) 9.09 percent
10. D) 9.47 percent
11. E) 10.36 percent

 

Answer:  B

Explanation:  Return on equity = ($1.22 × 60,000) / $840,000 = 8.71 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Ratio analysis

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

72) Western Adventures has earnings per share of $2.30 and dividends per share of $1.25. The total equity of the firm is $850,000. There are 40,000 shares of stock outstanding. What is the sustainable rate of growth?

2. A) 2.14 percent
3. B) 3.31 percent
4. C) 4.94 percent
5. D) 5.32 percent
6. E) 6.59 percent

 

Answer:  C

Explanation:  Sustainable growth rate = [($2.30 × 40,000) / $850,000] × [1 − ($1.25/$2.30)] = 4.94 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

73) The Grand Isle has 12,000 shares of stock outstanding at a market price of $31.60 per share. The book value per share is $12.08. The firm has earnings per share of $1.86 and a dividend payout ratio of 0.40. What is the firm’s sustainable rate of growth?

8. A) 8.88 percent
9. B) 9.24 percent
10. C) 9.71 percent
11. D) 10.57 percent
12. E) 10.86 percent

 

Answer:  B

Explanation:  Sustainable growth rate = ($1.86 / $12.08) × (1 − 0.40) = 9.24 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

74) Wilkinson and Daughters has net income of $415,400, total assets of $2.2 million, and total liabilities of $1.08 million. The company paid $270,000 in dividends. What is the firm’s sustainable rate of growth?

9. A) 9.69 percent
10. B) 11.06 percent
11. C) 12.98 percent
12. D) 13.93 percent
13. E) 14.15 percent

 

Answer:  C

Explanation:  Sustainable growth rate = [$415,400 / ($2.2m − $1.08m)] × [($415,400 − $270,000) / $415,400] = 12.98 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

75) The Watermelon Patch has a retention ratio of 0.75, dividends of $50,000, and total equity of $3.5 million. What is the firm’s sustainable rate of growth?

1. A) 1.58 percent
2. B) 4.29 percent
3. C) 6.30 percent
4. D) 7.38 percent
5. E) 8.54 percent

 

Answer:  B

Explanation:  Sustainable growth rate = {[($50,000 / (1 – 0.75)] / $3.5m} × 0.75 = 4.29 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

76) Southern Foods just paid an annual dividend of $1.10 a share. Management estimates the dividend will increase by 10 percent a year for the next four years. After that, the annual dividend growth rate is estimated at 3.2 percent. The required rate of return is 12 percent. What is the value of this stock today?

12. A) $12.55
13. B) $13.00
14. C) $14.54
15. D) $15.81
16. E) $16.21

 

Answer:  E

Explanation:

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

77) The common stock of A.G. Tailor has a required return of 16 percent. The latest press release stated that last year’s dividend was $0.90 per share and that future dividends will increase by 15 percent for the following 3 years. After that, the dividend growth rate will be 3 percent indefinitely. What is one share of this stock worth to you today?

8. A) $8.42
9. B) $9.60
10. C) $10.26
11. D) $10.75
12. E) $12.03

 

Answer:  B

Explanation:

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

78) Mountain View Nursery is a relatively young firm which just paid its first annual dividend of $0.35 a share. Management projects dividend increases of 12 percent per year for five years followed by a constant growth rate of 3 percent annually. What is this stock worth today if the applicable discount rate is 11 percent?

3. A) $3.59
4. B) $4.66
5. C) $5.23
6. D) $6.01
7. E) $6.51

 

Answer:  E

Explanation:

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

79) The last dividend paid by New Technologies was an annual dividend of $1.40 a share. Dividends for the next 3 years will be increased at an annual rate of 8 percent. After that, dividends are expected to increase by 3 percent each year. The discount rate is 16 percent. What is the current value of this stock?

10. A) $10.40
11. B) $12.60
12. C) $13.33
13. D) $14.10
14. E) $15.55

 

Answer:  B

Explanation:

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

80) Ultra Fine Furnishings is in the process of selling its peripheral businesses and focusing on its upscale clients. In conjunction with this reorganization, the dividend will be decreased by 10 percent for the next three years. After that, the dividend will resume increasing at an annual rate of 5 percent. The required return on this stock is 14 percent and the last dividend paid was $2.40 a share. What is one share of this stock worth today?

17. A) $17.34
18. B) $18.08
19. C) $18.35
20. D) $19.68
21. E) $20.72

 

Answer:  C

Explanation:

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

81) Perry Adventures last annual dividend was $0.70 a share. The firm will increase the dividend by 5 percent for the next 4 years and thereafter increase the dividend by 3 percent annually. What is this stock worth today if the required return is 10 percent?

10. A) $10.38
11. B) $11.05
12. C) $11.30
13. D) $13.97
14. E) $14.08

 

Answer:  B

Explanation:

 

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

82) Newcomer Mills is a relatively new firm which will retain all of its earnings for the next four years. Four years from now, the firm expects to pay its first dividend of $0.25 a share. After that, it intends to increase the dividend by 4 percent annually. What is the value of this stock today at a discount rate of 12 percent?

1. A) $1.53
2. B) $1.78
3. C) $2.04
4. D) $2.22
5. E) $2.60

 

Answer:  D

Explanation:

p4	=	$0.25(1.04)	=	$3.25
		0.12 − 0.04

 

 

p0	=	$3.25 + 0.25	=	$2.22
		1.124

 

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

83) Best Value Outlet recently announced that it intends to pay dividends of $0.40, $0.60, $0.75, and $1.00 per share over the next four years, respectively. After that, the plan is to increase the dividend by 3.5 percent annually. What is the current value of this stock if the applicable discount rate is 13.5 percent?

6. A) $6.44
7. B) $7.83
8. C) $8.17
9. D) $9.55
10. E) $13.10

 

Answer:  C

Explanation:

p4	=	$1.00(1.035)	=	$10.35
		0.135 − 0.035

 

 

p0	=	$0.40	+	$0.60	+	$0.75	+	$1.00 + $10.35	=	$8.17
		1.1351		1.1352		1.1353		1.1354

 

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Dividend discount model

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

84) Quality Home Made Ice Cream has plans to pay decreasing annual dividends of $1.60, $1.50, and $1.35 over the next three years, respectively. After that, the firm will increase the dividend by 5 percent each year. What is the value of this stock today at a discount rate of 11 percent?

19. A) $19.26
20. B) $19.54
21. C) $19.69
22. D) $19.93
23. E) $20.92

 

Answer:  E

Explanation:

D(1)	$	1.60
D(2)	$	1.50
D(3)	$	1.35
g(c)		5	%
r		11	%
p(3)	$	23.63
CF1	$	1.60
CF2	$	1.50
CF3	$	24.98
NPV	$	20.92

 

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Dividend discount model

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

85) The Shoe Box will not pay a dividend for the next two years. The following two years, it will pay annual dividends of $1 per share. Starting in year 5, the dividends will increase by 4 percent annually. The discount rate is 8 percent. What is the value of this stock today?

18. A) $18.18
19. B) $20.64
20. C) $22.63
21. D) $24.08
22. E) $27.09

 

Answer:  B

Explanation:

p4	=	$1.00(1.04)	=	$26
		0.08 − 0.04

 

 

p0	=	$0	=	$0	=	$1	=	$1.00 + $26	=	$20.64
		1.081		1.082		1.083		1.084

 

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Dividend discount model

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

86) The current book value per share of B.L. Black & Sons is $5.35 and the required return on the stock is 15.5 percent. The firm expects earnings per share of $2.25 next year with annual earnings growth of 4.5 percent. What is the current market value of this stock?

9. A) $9.16
10. B) $10.91
11. C) $13.88
12. D) $18.27
13. E) $20.30

 

Answer:  D

Explanation:

p0	=	$2.25 −($5.35 × 0.045)	=	$18.27
		0.155 − 0.045

 

Difficulty: 2 Medium

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

 

 

87) The Diamond Outlet has current earnings per share of $2.20 and an expected earnings growth rate of 2.3 percent. The required return on the stock is 14 percent and the current book value per share is $15.25. What is the current market value of this stock?

15. A) $15.07
16. B) $15.62
17. C) $15.96
18. D) $16.24
19. E) $16.67

 

Answer:  D

Explanation:

p0	=	($2.20 × 1.023)− ($15.25 × 0.023)	=	$16.24
		0.14 − 0.023

 

Difficulty: 2 Medium

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

 

88) Leslie Apparel has a current book value per share of $5.15 and current earnings per share of $1.13. The required return is 14 percent and the expected earnings growth rate is 4.5 percent. What is one share of this stock worth today?

7. A) $7.44
8. B) $8.77
9. C) $9.99
10. D) $10.65
11. E) $11.13

 

Answer:  C

Explanation:

p0	=	($1.13 × 1.045) − ($5.15 × 0.045)	=	$9.99
		0.14 − 0.045

 

Difficulty: 2 Medium

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

 

 

89) A firm has a current book value per share of $21.10 and a market price per share of $37.57. Next year’s earnings are expected to be $5.60 per share and the expected earnings growth rate is 2.5 percent. What is the required rate of return on this stock?

1. A) 14 percent
2. B) 15 percent
3. C) 16 percent
4. D) 17 percent
5. E) 18 percent

 

Answer:  C

Explanation:

p0	=	$5.60 −($21.20 × 0.025)	=	$37.57;k	=	16%
		k − 0.025

 

Difficulty: 2 Medium

Section:  6.4 The Residual Income Model

Topic:  Residual income model (EVA)

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

90) Lambert Corporation reported net income of $60 million for last year. Depreciation expense totaled $20 million and capital expenditures came to $5 million. Free cash flow is expected to grow at a rate of 4.5% for the foreseeable future. Lambert faces a 40% tax rate and has a 0.45 debt to equity ratio with $255 million (market value) in debt outstanding. Lambert’s equity beta is 1.30, the risk-free rate is currently 5% and the market risk premium is estimated to be 6.5%. What is the current total value of Lambert’s equity (in millions)?

655. A) $655.90
656. B) $731.20
657. C) $840.61
658. D) $951.26
659. E) $1,025.95

 

Answer:  C

Explanation:

Step 1	Asset beta	1.30/(1+.45(1-.40))		1.0236
Step 2	Required Return	5% + 6.5%(1.0236)		11.65	%
Step 3	FCF	$60 + 20 − 5m =	$	75
Step 4	Firm Value	$75(1+0.045)/(0.1165 − 0.045)		1095.611
Step 5	Equity value	$1,095.611 − 255 =	$	840.61

 

Difficulty: 2 Medium

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

91) Beach & Company reported net income of $40 million for last year. Depreciation expense totaled $18 million and capital expenditures came to $8 million. Free cash flow is expected to grow at a rate of 5% for the foreseeable future. Beach faces a 40% tax rate and has a 0.50 debt to equity ratio with $200 million (market value) in debt outstanding. Beach’s equity beta is 1.25, the risk-free rate is currently 4.5% and the market risk premium is estimated to be 8%. What is the current total value of Beach & Company (in millions)?

655. A) $655.90
656. B) $730.18
657. C) $840.95
658. D) $919.46
659. E) $1,025.95

 

Answer:  B

Explanation:

Step 1:	Asset beta	1.25/(1+ 0.5(1-0.40))		0.96
Step 2:	Required Return	4.5% + 0.96(8%)		12.19	%
Step 3:	FCF	$40 + 18 − 8 million =	$	50	million
Step 4:	Firm Value	$50(1 + 0.05/(0.1219 − 0.05)	$	730.18

 

Difficulty: 2 Medium

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

 

 

 

92) McKenzie, Inc. reported net income of $8.5 million for last year. Depreciation expense totaled $5 million and capital expenditures came to $2 million. Free cash flow is expected to grow at a rate of 2.5% for the foreseeable future. McKenzie faces a 40% tax rate and has a 0.50 debt to equity ratio with $20 million (market value) in debt outstanding. McKenzie’s equity beta is 1.4, the risk- free rate is currently 5% and the market risk premium is estimated to be 7.5%. McKenzie has 10 million shares of common stock outstanding. What is the current value of a share of McKenzie stock?

6. A) $6.62
7. B) $7.32
8. C) $8.45
9. D) $9.12
10. E) $10.25

Answer:  D

Explanation:

Step 1	Asset beta	1.40/(1+.05(1-.40))		1.080
Step 2	Required Return	5% + 7.5%(1.08)		13.10	%
Step 3	FCF	$8.5 + 5 − 2m =	$	11,500,000
Step 4	Firm Value	$11.5(1+0.025)/(0.1310 − 0.025)	$	111,202,830
Step 5	Equity value	$111,20 − 20 =	$	91,202,830
Step 6	Share Value	$99.20/10	$	9.12

 

Difficulty: 2 Medium

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

 

 

93) Standard, Inc. reported net income of $35 million for last year. Depreciation expense totaled $20 million and capital expenditures came to $7 million. Free cash flow is expected to grow at a rate of 6% for the foreseeable future. Stuart faces a 40% tax rate and has a 0.40 debt to equity ratio with $120 million (market value) in debt outstanding. Standard’s equity beta is 1.25, the risk-free rate is currently 5% and the market risk premium is estimated to be 7.5%. What is the current value (in millions) of Standard’s equity?

237. A) $237.34
238. B) $352.42
239. C) $427.42
240. D) $556.79
241. E) $655.55

 

Answer:  E

Explanation:

Step 1	Asset beta	1.25/(1+.4(1-.40))		1.0081
Step 2	Required Return	5% + 7.5%(1.0081)		12.56	%
Step 3	FCF	$35 + 20 − 7m =	$	48.00
Step 4	Firm Value	$48(1+0.06)/(0.1256 − 0.06)		775.553
Step 5	Equity value	$775.553 − 120 =	$	655.55

 

Difficulty: 2 Medium

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

94) A firm has net income of $198,500 and total equity of 1.15 million. There are 220,000 shares of stock outstanding at a price per share of $14.80. What is the firm’s price-earnings ratio?

16. A) 16.21
17. B) 16.40
18. C) 17.09
19. D) 17.28
20. E) 17.94

 

Answer:  B

Explanation:  P/E = $14.80/($198,500/220,000) = 16.40

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

 

95) L.B. Jay has net income of $38,000, total assets of $437,000, total liabilities of $208,000, and a price-book ratio of 3.8. There are 60,000 shares of stock outstanding. What is the firm’s price-earnings ratio?

18. A) 18.72
19. B) 19.11
20. C) 19.28
21. D) 20.80
22. E) 22.90

 

Answer:  E

Explanation:  P/E = {[($437,000 – $208,000)/60,000] × 3.8}/($38,000/60,000) = 22.90

Difficulty: 2 Medium

Section:  6.6 Price Ratio Analysis

Topic:  Ratio analysis

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

96) Miller’s Farm has 120,000 shares of stock outstanding, sales of $850,000, and net income of $55,000. Financial analysts believe the price-earnings ratio for this firm should be 15.8. Given this information, what should be the current stock price?

7. A) $7.24
8. B) $8.87
9. C) $14.85
10. D) $14.57
11. E) $15.21

 

Answer:  A

Explanation:  P0 = ($55,000/120,000) × 15.8 = $7.24

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

 

97) Electronics Galore has historically had a P/E ratio of 22.1. This ratio is considered a good estimate of the future ratio. The firm currently has EPS of $1.78. These earnings are expected to increase by 5.0 percent next year. What is the expected price of this stock one year from now?

39. A) $39.31
40. B) $40.96
41. C) $41.30
42. D) $42.78
43. E) $43.79

 

Answer:  C

Explanation:  Expected price = $1.78 × (1 + .05) × 22.1 = $41.30

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

98) Historically, Jones Trucking has had a P/E ratio of 14.6. The firm has current net income of $92,000 with 85,000 shares of stock outstanding. The EPS growth rate is 4.5 percent. What is the expected price of this stock one year from now?

15. A) $15.32
16. B) $15.85
17. C) $16.41
18. D) $16.51
19. E) $17.10

 

Answer:  D

Explanation:  Expected price = ($92,000/85,000) × (1 + 0.045) × 14.6 = $16.51

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

 

99) The Retail Box has a historical P/CF ratio of 21.5. The current CFPS is $1.42 and the projected CFPS growth rate is 5.6 percent. The current EPS is $1.02. What is the expected price of this stock one year from now?

30. A) $30.53
31. B) $32.24
32. C) $32.88
33. D) $34.11
34. E) $34.20

 

Answer:  B

Explanation:  Expected price = $1.42 × (1 + .056) × 21.5 = $32.24

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

100) The Satellite Shoppe has current sales per share of $10.55. The sales per share are expected to increase at an annual rate of 12 percent. The historical P/E ratio is 16.2 and the historical P/S ratio is 9.8. What is the expected price of this stock one year from now?

59. A) $59.72
60. B) $66.67
61. C) $71.50
62. D) $115.80
63. E) $129.00

 

Answer:  D

Explanation:  Expected price = $10.55 × (1 + 0.12) × 9.8 = $115.80

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

 

 

 

101) Currently, Southern Foods has sales of $1.32 million, net profit of $521,400, and 125,000 shares of stock outstanding. The sales and net profit are each expected to grow by 6 percent annually. The historical P/S ratio is 7.8. What is the expected price of this stock one year from now?

32. A) $32.54
33. B) $34.49
34. C) $82.37
35. D) $85.15
36. E) $87.31

 

Answer:  E

Explanation:  Expected price = ($1,320,000/125,000) × (1 + 0.06) × 7.8 = $87.31

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

102) Cayman Boats plans to pay a $1.75 a share dividend at the end of each of the next 2 years. At the end of year 3, it will pay a final liquidating dividend of $25 a share. After that, the company plans to close its doors permanently. What is the current value of this stock at a discount rate of 10 percent?

19. A) $19.89
20. B) $20.26
21. C) $21.82
22. D) $23.80
23. E) $24.50

 

Answer:  C

Explanation:

p0	=	$1.75	+	$1.75	+	$25	=	$21.82
		(1 + 0.10)1		(1 + 0.10)2		(1 + 0.10)3

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Dividend discount model

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

 

103) The Boston House increases its dividend each year. The next annual dividend is expected to be $2.25 a share. Future dividends will increase by 5.0 percent annually. What is the current value of this stock if the discount rate is 13 percent?

28. A) $28.91
29. B) $28.13
30. C) $28.78
31. D) $29.00
32. E) $29.17

 

Answer:  B

Explanation:

p0	=	$2.25	=	$28.13
		0.13 + 0.05

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

104) CB Industries stock is valued at $16.80 a share. The firm pays annual dividends at an increasing rate of 4.5 percent annually. Next year’s dividend will be $1.90 per share. What is the required return on this stock?

11. A) 11.03 percent
12. B) 12.50 percent
13. C) 13.62 percent
14. D) 14.00 percent
15. E) 15.81 percent

 

Answer:  E

Explanation:

r	=	D1	+	g =	$1.90	+	0.45	=	15.81%
		P0			$16.80

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Constant-growth stock

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

 

105) A firm has paid annual dividends of $1.41, $1.43, $1.55, $1.62, $1.64, and $1.68 per share over the past 6 years, respectively. What is the geometric average growth rate for these dividends?

3. A) 3.19 percent
4. B) 3.28 percent
5. C) 3.48 percent
6. D) 3.57 percent
7. E) 3.74 percent

 

Answer:  D

Explanation:

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

106) Bait ‘n Tackle started paying dividends 4 years ago. The annual dividends thus far have been $0.50, $0.55, $0.60, and $0.65, respectively. What is the arithmetic average dividend growth rate?

6. A) 6.33 percent
7. B) 8.58 percent
8. C) 9.14 percent
9. D) 10.80 percent
10. E) 11.13 percent

 

Answer:  C

Explanation:

Dividends	Growth rate
$0.50
$0.55		10.00	%
$0.60		9.09	%
$0.65		8.33	%
		9.14	%

 

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Arithmetic, geometric, and dollar-weighted returns

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

 

 

 

107) Canadian Adventures has earnings per share of $2.86 and dividends per share of $1.80. The total equity of the firm is $750,000. There are 38,000 shares of stock outstanding. What is the sustainable rate of growth?

2. A) 2.14 percent
3. B) 3.31 percent
4. C) 4.94 percent
5. D) 5.37 percent
6. E) 6.59 percent

 

Answer:  D

Explanation:  Sustainable growth rate = [($2.86 × 38,000) / $750,000] × [1− ($1.80/$2.86)] = 5.37 percent

Difficulty: 1 Easy

Section:  6.2 The Dividend Discount Model

Topic:  Growth rates

Learning Objective:  06-01 The basic dividend discount model.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation

108) Georgia Nursery is a relatively young firm which just paid its first annual dividend of $0.50 a share. Management projects dividend increases of 15 percent per year for five years followed by a constant growth rate of 5.0 percent annually. What is this stock worth today if the applicable discount rate is 10 percent?

13. A) $13.59
14. B) $14.66
15. C) $15.98
16. D) $16.16
17. E) $16.51

 

Answer:  C

Explanation:

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Multi-stage growth stock

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

109) Comfort Ice Cream has plans to pay decreasing annual dividends of $1.75, $1.60, and $1.45 over the next three years, respectively. After that, the firm will increase the dividend by 4 percent each year. What is the value of this stock today at a discount rate of 12 percent?

17. A) $17.29
18. B) $17.54
19. C) $17.69
20. D) $17.93
21. E) $18.92

 

Answer:  A

Explanation:

D(1)	$	1.75
D(2)	$	1.60
D(3)	$	1.45
g(c)		4	%
r		12	%
p(3)	$	18.85
CF1	$	1.75
CF2	$	1.60
CF3	$	20.30
NPV	$	17.29

 

Difficulty: 2 Medium

Section:  6.3 The Two-Stage Dividend Growth Model

Topic:  Dividend discount model

Learning Objective:  06-02 The two-stage dividend growth model.

Bloom’s:  Level 3 Apply

 

 

110) Lansing Corporation reported net income of $65 million for last year. Depreciation expense totaled $15 million and capital expenditures came to $6 million. Free cash flow is expected to grow at a rate of 4.5% for the foreseeable future. Lansing faces a 40% tax rate and has a 0.35 debt to equity ratio with $260 million (market value) in debt outstanding. Lansing’s equity beta is 1.35, the risk-free rate is currently 5% and the market risk premium is estimated to be 6.5%. What is the current total value of Lansing’s equity (in millions)?

655. A) $655.90
656. B) $737.54
657. C) $840.61
658. D) $951.26
659. E) $1,025.95

 

Answer:  B

Explanation:

Step 1	Asset beta	1.35/(1+.35(1−.40))		1.1157
Step 2	Required Return	5% + 6.5%(1.1157)		12.25
Step 3	FCF	$65 + 15 − 6m =	$	74.00
Step 4	Firm Value	$74(1+0.045)/(0.1225 − 0.045)	$	997.541
Step 5	Equity value	$997.541 − 260 =	$	737.54

 

Difficulty: 2 Medium

Topic:  Free cash flow models and valuations

Learning Objective:  06-03 The residual income and free cash flow models.

Bloom’s:  Level 3 Apply

111) Toys Galore has historically had a P/E ratio of 18.5. This ratio is considered a good estimate of the future ratio. The firm currently has EPS of $2.10. These earnings are expected to increase by 5.0 percent next year. What is the expected price of this stock one year from now?

39. A) $39.31
40. B) $40.79
41. C) $41.30
42. D) $42.78
43. E) $43.79

 

Answer:  B

Explanation:  Expected price = $2.10 × (1 + .05) × 18.5 = $40.79

Difficulty: 1 Easy

Section:  6.6 Price Ratio Analysis

Topic:  Stock valuation using multiples

Learning Objective:  06-04 Price ratio analysis.

Bloom’s:  Level 3 Apply

Accessibility:  Keyboard Navigation