Intermediate Financial Management 11th Edition by Eugene F. Brigham - Test Bank

Intermediate Financial Management 11th Edition by Eugene F. Brigham – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

CHAPTER 5 BASIC STOCK  VALUATION

(Difficulty Levels:  Easy, Easy/Medium, Medium, Medium/Hard, and Hard)

 

 

Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines.

 

Multiple Choice:  True/False

 

(5.1) Proxy                              F G                    Answer: a  EASY

[1].    A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock.  Proxies can be important tools relating to control of firms.

 

1. True
2. False

 

(5.1) Preemptive right                   F G                     Answer: a EASY

[2].    The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm.  This right helps protect current stockholders against both dilution of control and dilution of value.

 

1. True
2. False

 

(5.1) Preemptive right                   F G                    Answer: b  EASY

[3].    If a firm’s stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting to vote to replace the management.  Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.

 

1. True
2. False

 

(5.2) Classified stock                   F G                    Answer: a  EASY

[4].    Classified stock differentiates various classes of common stock, and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don’t want to relinquish voting control.

 

1. True
2. False

 

(5.2) Founders’ shares                   F G                    Answer: a  EASY

[5].    Founders’ shares are a type of classified stock where the shares are owned by the firm’s founders, and they generally have more votes per share than the other classes of common stock.

 

1. True
2. False

(5.5) Total stock returns                F G                    Answer: b  EASY

[6].    The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.

 

1. True
2. False

 

(5.5) Common stock cash flows            F G                    Answer: a  EASY

[7].    The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

 

1. True
2. False

 

(5.5) Value: investment horizon          F G                    Answer: b  EASY

[8].    According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.

 

1. True
2. False

 

(5.5) Marginal investor and price        F G                    Answer: a  EASY

[9].    When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade.

 

1. True
2. False

 

(5.6) Constant growth model              F G                    Answer: a  EASY

[10].   The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.

 

1. True
2. False

 

(5.8) Nonconstant growth model           F G                    Answer: a  EASY

[11].   According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period.

 

1. True
2. False

 

(5.9) Free cash flows and valuation      F G                    Answer: a  EASY

[12].   Projected free cash flows should be discounted at the firm’s weighted average cost of capital to find the value of its operations.

 

1. True
2. False

 

(5.11) Preferred stock                   F G                    Answer: b  EASY

[13].   Preferred stock is a hybrid–a sort of cross between a common stock and a bond–in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.

 

1. True
2. False

 

(5.11) Preferred stock                   F G                    Answer: a  EASY

[14].   From an investor’s perspective, a firm’s preferred stock is generally considered to be less risky than its common stock but more risky than its bonds.  However, from a corporate issuer’s standpoint, these risk relationships are reversed: Bonds are the most risky for the firm, preferred is next, and common is least risky.

 

1. True
2. False

 

(5.12) Stock market equilibrium          F G                    Answer: a  EASY

[15].   If a stock’s expected return as seen by the marginal investor exceeds this investor’s required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

 

1. True
2. False

 

(5.12) Stock market equilibrium          F G                    Answer: a  EASY

[16].   If a stock’s market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor’s estimate of the intrinsic value.

 

1. True
2. False

 

(5.12) Stock market equilibrium          F G                    Answer: a  EASY

[17].   For a stock to be in equilibrium, two conditions are necessary: (1) The stock’s market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor’s required return.

 

1. True
2. False

 

(5.12) Stock market equilibrium          F G                    Answer: b  EASY

[18].   Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock’s market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor’s required return?  If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.

 

1. True
2. False

 

Multiple Choice:  Conceptual

 

Some of the questions require calculations.

 

(5.6) Constant growth model              C G                    Answer: b  EASY

[19].   Which of the following statements is CORRECT?

 

1. If a stock has a required rate of return r_s = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
2. The stock valuation model, P₀ = D₁/(r_s – g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.
3. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
4. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.
5. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.

 

(5.7) Required return                    C G                    Answer: d  EASY

[20].   If a firm’s expected growth rate increased then its required rate of return would

 

1. decrease.
2. fluctuate less than before.
3. fluctuate more than before.
4. possibly increase, possibly decrease, or possibly remain constant.
5. increase.

 

(5.7) Required return                    C G                    Answer: b  EASY

[21].   You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think

 

1. the stock should be sold.
2. the stock is a good buy.
3. management is probably not trying to maximize the price per share.
4. dividends are not likely to be declared.
5. the stock is experiencing supernormal growth.

 

(5.12) Market equilibrium                C G                    Answer: a  EASY

[22].   If markets are in equilibrium, which of the following conditions will exist?

 

1. Each stock’s expected return should equal its required return as seen by the marginal investor.
2. All stocks should have the same expected return as seen by the marginal investor.
3. The expected and required returns on stocks and bonds should be equal.
4. All stocks should have the same realized return during the coming year.
5. Each stock’s expected return should equal its realized return as seen by the marginal investor.

 

(5.1) Preemptive right                   C G                  Answer: c  MEDIUM

[23].   The preemptive right is important to shareholders because it

 

1. will result in higher dividends per share.
2. is included in every corporate charter.
3. protects the current shareholders against a dilution of their ownership interests.
4. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
5. allows managers to buy additional shares below the current market price.

 

(5.2) Classified stock                   C G                  Answer: d  MEDIUM

[24].   Companies can issue different classes of common stock.  Which of the following statements concerning stock classes is CORRECT?

 

1. All common stocks, regardless of class, must have the same voting rights.
2. All firms have several classes of common stock.
3. All common stock, regardless of class, must pay the same dividend.
4. Some class or classes of common stock are entitled to more votes per share than other classes.
5. All common stocks fall into one of three classes: A, B, and C.

 

(5.6) Constant growth model              C G                  Answer: e  MEDIUM

[25].   Which of the following statements is CORRECT?

 

1. Two firms with the same expected dividend and growth rates must also have the same stock price.
2. It is appropriate to use the constant growth model to estimate a stock’s value even if its growth rate is never expected to become constant.
3. If a stock has a required rate of return r_s = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
4. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
5. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

 

(5.6) Declining constant growth          C G                  Answer: d  MEDIUM

[26].   A stock is expected to pay a year-end dividend of $2.00, i.e., D₁ = $2.00.  The dividend is expected to decline at a rate of 5% a year forever (g = -5%).  If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

 

1. The company’s dividend yield 5 years from now is expected to be 10%.
2. The constant growth model cannot be used because the growth rate is negative.
3. The company’s expected capital gains yield is 5%.
4. The company’s expected stock price at the beginning of next year is $9.50.
5. The company’s current stock price is $20.

 

(5.7) Constant growth stock              C G                  Answer: d  MEDIUM

[27].   If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.

 

1. The stock’s dividend yield is 5%.
2. The price of the stock is expected to decline in the future.
3. The stock’s required return must be equal to or less than 5%.
4. The stock’s price one year from now is expected to be 5% above the current price.
5. The expected return on the stock is 5% a year.

 

(5.7) Expected and required returns      C G                  Answer: a  MEDIUM

[28].   Stocks A and B have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

A          B

Required return              10%         12%

Market price                 $25         $40

Expected growth               7%          9%

 

1. These two stocks must have the same dividend yield.
2. These two stocks should have the same expected return.
3. These two stocks must have the same expected capital gains yield.
4. These two stocks must have the same expected year-end dividend.
5. These two stocks should have the same price.

 

(5.7) Expected and required returns      C G                  Answer: d  MEDIUM

[29].   Stocks A and B have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

A          B

Price                        $25         $40

Expected growth               7%          9%

Expected return              10%         12%

 

1. The two stocks could not be in equilibrium with the numbers given in the question.
2. A’s expected dividend is $0.50.
3. B’s expected dividend is $0.75.
4. A’s expected dividend is $0.75 and B’s expected dividend is $1.20.
5. The two stocks should have the same expected dividend.

 

(5.7) Expected and required returns      C G                  Answer: e  MEDIUM

[30].   Stocks A and B have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

A          B

Price                        $25         $25

Expected growth (constant)   10%          5%

Required return              15%         15%

 

1. Stock A has a higher dividend yield than Stock B.
2. Currently the two stocks have the same price, but over time Stock B’s price will pass that of A.
3. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high as Stock B’s.
4. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
5. Stock A’s expected dividend at t = 1 is only half that of Stock B.

 

(5.7) Expected and required returns      C G                  Answer: b  MEDIUM

[31].   Stocks X and Y have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

X          Y

Price                        $30         $30

Expected growth (constant)    6%          4%

Required return              12%         10%

 

1. Stock Y has a higher dividend yield than Stock X.
2. One year from now, Stock X’s price is expected to be higher than Stock Y’s price.
3. Stock X has the higher expected year-end dividend.
4. Stock Y has a higher capital gains yield.
5. Stock X has a higher dividend yield than Stock Y.

 

 

(5.7) Expected and required returns      C G                  Answer: a  MEDIUM

[32].   Stock X has the following data.  Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT?

 

Expected dividend, D₁                $3.00

Current Price, P₀                      $50

Expected constant growth rate         6.0%

 

1. The stock’s expected dividend yield and growth rate are equal.
2. The stock’s expected dividend yield is 5%.
3. The stock’s expected capital gains yield is 5%.
4. The stock’s expected price 10 years from now is $100.00.
5. The stock’s required return is 10%.

 

(5.7) Expected and required returns      C G                  Answer: a  MEDIUM

[33].   Stocks X and Y have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

X          Y

Price                        $25         $25

Expected dividend yield       5%          3%

Required return              12%         10%

 

1. Stock X pays a higher dividend per share than Stock Y.
2. One year from now, Stock X should have the higher price.
3. Stock Y has a lower expected growth rate than Stock X.
4. Stock Y has the higher expected capital gains yield.
5. Stock Y pays a higher dividend per share than Stock X.

 

(5.7) Expected and required returns      C G                  Answer: c  MEDIUM

[34].   Merrell Enterprises’s stock has an expected return of 14%.  The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share.  Which of the following statements is CORRECT?

 

1. The stock’s dividend yield is 8%.
2. The current dividend per share is $4.00.
3. The stock price is expected to be $54 a share one year from now.
4. The stock price is expected to be $57 a share one year from now.
5. The stock’s dividend yield is 7%.

 

(5.7) Dividend yield and g               C G                  Answer: e  MEDIUM

[35].   Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return.  Which of the following statements is CORRECT?

 

1. Stock B must have a higher dividend yield than Stock A.
2. Stock A must have a higher dividend yield than Stock B.
3. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B’s.
4. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
5. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B’s.

 

(5.7) Dividend yield and g               C G                  Answer: a  MEDIUM

[36].   Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return.  Which of the following statements is CORRECT?

 

1. If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
2. If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
3. The two stocks must have the same dividend growth rate.
4. The two stocks must have the same dividend yield.
5. The two stocks must have the same dividend per share.

(5.7) Dividend yield and g               C G                  Answer: e  MEDIUM

[37].   Which of the following statements is CORRECT, assuming stocks are in equilibrium?

 

1. Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
2. A stock’s dividend yield can never exceed its expected growth rate.
3. A required condition for one to use the constant growth model is that the stock’s expected growth rate exceeds its required rate of return.
4. Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return.
5. The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.

 

(5.11) Preferred stock concepts          C G                  Answer: a  MEDIUM

[38].   Which of the following statements is CORRECT?

 

1. The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.
2. Corporations cannot buy the preferred stocks of other corporations.
3. Preferred dividends are not generally cumulative.
4. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.
5. Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.

 

(5.11) Preferred stock concepts          C G                  Answer: a  MEDIUM

[39].   Which of the following statements is CORRECT?

 

1. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
2. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.
3. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.
4. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.
5. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.

 

(5.12) Market equilibrium                C G                  Answer: d  MEDIUM

[40].   For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

 

1. The past realized return must be equal to the expected return during the same period.
2. the required return must equal the realized return in all periods.
3. the expected return must be equal to both the required future return and the past realized return.
4. the expected future returns must be equal to the required return.
5. the expected future return must be less than the most recent past realized return.

 

(Comp.) Common stock concepts            C G                  Answer: b  MEDIUM

[41].   Which of the following statements is CORRECT?

 

1. The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.
2. The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm’s common stock.
3. The stock valuation model, P₀ = D₁/(r_s – g), cannot be used for firms that have negative growth rates.
4. The stock valuation model, P₀ = D₁/(r_s – g), can be used only for firms whose growth rates exceed their required returns.
5. If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.

 

(Comp.) Common stock concepts            C G                  Answer: e  MEDIUM

[42].   The required returns of Stocks X and Y are r_X = 10% and r_Y = 12%.  Which of the following statements is CORRECT?

 

1. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.
2. If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.
3. The stocks must sell for the same price.
4. Stock Y must have a higher dividend yield than Stock X.
5. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

 

 

 

(Comp.) Constant growth model: CAPM      C G                  Answer: a  MEDIUM

[43].   Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

   A          B 

Beta                          1.10      0.90

Constant growth rate         7.00%     7.00%

 

1. Stock A must have a higher dividend yield than Stock B.
2. Stock B’s dividend yield equals its expected dividend growth rate.
3. Stock B must have the higher required return.
4. Stock B could have the higher expected return.
5. Stock A must have a higher stock price than Stock B.

 

 

Problems

 

Most of these problems are straightforward and only moderately difficult.  However, a few of the later ones are relatively difficult and should be used primarily on take-home exams for students with some experience with Excel.  Problems with * in the topic line are nonalgorithmic.

 

(5.6) Constant growth valuation          C G                    Answer: c  EASY

[44].   A stock is expected to pay a dividend of $0.75 at the end of the year.  The required rate of return is r_s = 10.5%, and the expected constant growth rate is g = 6.4%.  What is the stock’s current price?

 

17. $17.39
18. $17.84
19. $18.29
20. $18.75
21. $19.22

 

(5.6) Constant growth valuation          C G                    Answer: e  EASY

[45].   A stock just paid a dividend of D₀ = $1.50.  The required rate of return is r_s = 10.1%, and the constant growth rate is g = 4.0%.  What is the current stock price?

 

23. $23.11
24. $23.70
25. $24.31
26. $24.93
27. $25.57

 

(5.6) Constant growth valuation          C G                    Answer: d  EASY

[46].   A share of Lash Inc.’s common stock just paid a dividend of $1.00.  If the expected long-run growth rate for this stock is 5.4%, and if investors’ required rate of return is 11.4%, what is the stock price?

 

16. $16.28
17. $16.70
18. $17.13
19. $17.57
20. $18.01

 

(5.6) Constant growth rate               C G                    Answer: e  EASY

[47].   Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D₁ = $1.25).  The stock sells for $32.50 per share, and its required rate of return is 10.5%.  The dividend is expected to grow at some constant rate, g, forever.  What is the equilibrium expected growth rate?

 

6. 6.01%
7. 6.17%
8. 6.33%
9. 6.49%
10. 6.65%

 

(5.6) Constant growth: future price        C G                    Answer: e  EASY

[48].   $35.50 per share is the current price for Foster Farms’ stock. The dividend is projected to increase at a constant rate of 5.50% per year.  The required rate of return on the stock, r_s, is 9.00%.  What is the stock’s expected price 3 years from today?

 

37. $37.86
38. $38.83
39. $39.83
40. $40.85
41. $41.69

 

(5.6) Constant growth: future price        C G                    Answer: e  EASY

[49].   Kelly Enterprises’s stock currently sells for $35.25 per share.  The dividend is projected to increase at a constant rate of 4.75% per year.  The required rate of return on the stock, r_s, is 11.50%.  What is the stock’s expected price 5 years from now?

 

40. $40.17
41. $41.20
42. $42.26
43. $43.34
44. $44.46

 

(5.7) Expected dividend yield            C G                    Answer: d  EASY

[50].   If D₁ = $1.25, g (which is constant) = 4.7%, and P₀ = $26.00, what is the stock’s expected dividend yield for the coming year?

 

4. 4.12%
5. 4.34%
6. 4.57%
7. 4.81%
8. 5.05%

 

(5.7) Expected dividend yield            C G                    Answer: b  EASY

[51].   If D₀ = $2.25, g (which is constant) = 3.5%, and P₀ = $50, what is the stock’s expected dividend yield for the coming year?

 

4. 4.42%
5. 4.66%
6. 4.89%
7. 5.13%
8. 5.39%

(5.7) Expected cap. gains yield          C G                    Answer: a  EASY

[52].   If D₁ = $1.50, g (which is constant) = 6.5%, and P₀ = $56, what is the stock’s expected capital gains yield for the coming year?

 

6. 6.50%
7. 6.83%
8. 7.17%
9. 7.52%
10. 7.90%

 

(5.7) Expected total return              C G                    Answer: e  EASY

[53].   If D₁ = $1.25, g (which is constant) = 5.5%, and P₀ = $44, what is the stock’s expected total return for the coming year?

 

7. 7.54%
8. 7.73%
9. 7.93%
10. 8.13%
11. 8.34%

 

(5.7) Expected total return              C G                    Answer: e  EASY

[54].   If D₀ = $1.75, g (which is constant) = 3.6%, and P₀ = $32.00, what is the stock’s expected total return for the coming year?

 

8. 8.37%
9. 8.59%
10. 8.81%
11. 9.03%
12. 9.27%

 

(5.11) Preferred stock valuation         C G                    Answer: e  EASY

[55].   Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share.  If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?

 

104. $104.27
105. $106.95
106. $109.69
107. $112.50
108. $115.38

 

(5.6) Constant g value: CAPM             C G                  Answer: a  MEDIUM

[56].   Dyer Furniture is expected to pay a dividend of D₁ = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future.  The company’s beta is 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%.  What is Dyer’s current stock price?

 

28. $28.90
29. $29.62
30. $30.36
31. $31.12
32. $31.90

 

(5.6) Constant g value: CAPM             C G                  Answer: a  MEDIUM

[57].   The Jameson Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future.  The company’s beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%.  What is Jameson’s current stock price, P₀?

 

18. $18.62
19. $19.08
20. $19.56
21. $20.05
22. $20.55

 

(5.6) Constant g value: CAPM             C G                  Answer: a  MEDIUM

[58].   National Advertising just paid a dividend of D₀ = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future.  The company’s beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50%.  What is the company’s current stock price?

 

14. $14.52
15. $14.89
16. $15.26
17. $15.64
18. $16.03

 

(5.6) Constant growth dividend           C G                  Answer: b  MEDIUM

[59].   Kellner Motor Co.’s stock has a required rate of return of 11.50%, and it sells for $25.00 per share.  Kellner’s dividend is expected to grow at a constant rate of 7.00%.  What was the last dividend, D₀?

 

1. $0.95
2. $1.05
3. $1.16
4. $1.27
5. $1.40

 

(5.6) Constant growth dividend           C G                  Answer: b  MEDIUM

[60].   Hirshfeld Corporation’s stock has a required rate of return of 10.25%, and it sells for $57.50 per share.  The dividend is expected to grow at a constant rate of 6.00% per year.  What is the expected year-end dividend, D₁?

 

2. $2.20
3. $2.44
4. $2.69
5. $2.96
6. $3.25

 

(5.6) Constant growth: future price        C G                  Answer: a  MEDIUM

[61].   Connolly Co.’s expected year-end dividend is D₁ = $1.60, its required return is r_s = 11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the future.  What is Connolly’s expected stock price in 7 years, i.e., what is ?

 

37. $37.52
38. $39.40
39. $41.37
40. $43.44
41. $45.61

 

(5.11) Preferred required return         C G                  Answer: e  MEDIUM

[62].   Alcott’s preferred stock pays a dividend of $1.00 per quarter.  If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return?

 

8. 8.03%
9. 8.24%
10. 8.45%
11. 8.67%
12. 8.89%

 

(5.11) Preferred required return         C G                  Answer: e  MEDIUM

[63].   Connor Publishing’s preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share.  What is its effective annual (not nominal) rate of return?

 

6. 6.62%
7. 6.82%
8. 7.03%
9. 7.25%
10. 7.47%

 

(5.8) Nonconstant growth valuation       C G             Answer: d  MEDIUM/HARD

[64].   Burke Tires just paid a dividend of D₀ = $1.32.  Analysts expect the company’s dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter.  The required return on this low-risk stock is 9.00%.  What is the best estimate of the stock’s current market value?

 

41. $41.59
42. $42.65
43. $43.75
44. $44.87
45. $45.99

 

(5.8) Nonconstant growth valuation       C G                    Answer: c  HARD

[65].   McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0.  The company’s last dividend, D₀, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%.  What is the current price of the common stock?

 

26. $26.77
27. $27.89
28. $29.05
29. $30.21
30. $31.42

 

(5.8) Nonconstant growth valuation       C G                    Answer: b  HARD

[66].   Orwell building supplies’ last dividend was $1.75.  Its dividend growth rate is expected to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of 6% forever.  Its required return (r_s) is 12%.  What is the best estimate of the current stock price?

 

41. $41.58
42. $42.64
43. $43.71
44. $44.80
45. $45.92

 

(5.8) Nonconstant growth valuation       C G                    Answer: a  HARD

[67].   The last dividend paid by Wilden Corporation was $1.55.  The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever.  The firm’s required return (r_s) is 12.0%.  What is the best estimate of the current stock price?

 

37. $37.05
38. $38.16
39. $39.30
40. $40.48
41. $41.70

 

(5.8) Nonconstant growth valuation       C G                    Answer: d  HARD

[68].   The last dividend paid by Coppard Inc. was $1.25.  The dividend growth rate is expected to be constant at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever.  If the firm’s required return (r_s) is 11%, what is its current stock price?

 

30. $30.57
31. $31.52
32. $32.49
33. $33.50
34. $34.50

 

(5.8) Nonconstant growth valuation       C G                    Answer: d  HARD

[69].   Sawchuck Consulting has been profitable for the last 5 years, but it has never paid a dividend.  Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter.  Management’s forecast of the future dividend stream, along with the forecasted growth rates, is shown below.  Assuming a required return of 11.00%, what is your estimate of the stock’s current value?

 

Year           0        1        2        3        4        5        6  

Growth rate   NA       NA       NA       NA     50.00%   25.00%    8.00%

Dividends   $0.000   $0.000   $0.000   $0.250   $0.375   $0.469   $0.506

 

9. $ 9.94
10. $10.19
11. $10.45
12. $10.72
13. $10.99

(5.8) Nonconstant growth rate*           C G               Answer: e  VERY HARD

[70].   The required return for Williamson Heating’s stock is 12%, and the stock sells for $40 per share.  The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D₄ = $1.00(1.30)⁴ = $2.8561.  After t = 4, the dividend is expected to grow at a constant rate of X% per year forever.  What is the stock’s expected constant growth rate after t = 4, i.e., what is X?

 

5. 5.17%
6. 5.44%
7. 5.72%
8. 6.02%
9. 6.34%

 

(5.8) Nonconstant value: Excel*          C G               Answer: d  VERY HARD

[71].   Julia Saunders is your boss and the treasurer of Foster Carter Enterprises (FCE). She asked you to help her estimate the intrinsic value of the company’s stock.  FCE just paid a dividend of $1.00, and the stock now sells for $15.00 per share.  Julia asked a number of security analysts what they believe FCE’s future dividends will be, based on their analysis of the company.  The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter.  Julia asked you to use that information to estimate the required rate of return on the stock, r_s, and she provided you with the following template for use in the analysis:

 

 

Julia told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts’ forecasted rates to get the correct forecasted dividends and then the estimated TV.  She also notes that the estimated value for r_s, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimated r_s.  The value of r_s that causes the calculated price to equal the actual price is the correct one.  She notes, though, that this trial-and-error process would be quite tedious, and that the correct r_s could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of r_s?

 

11. 11.84%
12. 12.21%
13. 12.58%
14. 12.97%
15. 13.36%

 

 

CHAPTER 5 ANSWERS AND SOLUTIONS

 

[1].    (5.1) Proxy                        F G                    Answer: a  EASY

[2].    (5.1) Preemptive right             F G                    Answer: a  EASY

[3].    (5.1) Preemptive right             F G                    Answer: b  EASY

[4].    (5.2) Classified stock             F G                    Answer: a  EASY

[5].    (5.2) Founders’ shares             F G                    Answer: a  EASY

[6].    (5.5) Total stock returns          F G                    Answer: b  EASY

[7].    (5.5) Common stock cash flows      F G                    Answer: a  EASY

[8].    (5.5) Value: investment horizon    F G                    Answer: b  EASY

[9].    (5.5) Marginal investor and price  F G                    Answer: a  EASY

[10].   (5.6) Constant growth model        F G                    Answer: a  EASY

[11].   (5.8) Nonconstant growth model     F G                    Answer: a  EASY

[12].   (5.9) Free cash flows and valuation  F G                    Answer: a  EASY

[13].   (5.11) Preferred stock             F G                    Answer: b  EASY

Preferred dividends don’t normally grow, and they are not guaranteed.

 

[14].   (5.11) Preferred stock             F G                    Answer: a  EASY

[15].   (5.12) Stock market equilibrium    F G                    Answer: a  EASY

[16].   (5.12) Stock market equilibrium    F G                    Answer: a  EASY

[17].   (5.12) Stock market equilibrium    F G                    Answer: a  EASY

[18].   (5.12) Stock market equilibrium    F G                    Answer: b  EASY

If one condition holds, then the other must also hold.

 

[19].   (5.6) Constant growth model        C G                    Answer: b  EASY

[20].   (5.7) Required return              C G                    Answer: d  EASY

[21].   (5.7) Required return              C G                    Answer: b  EASY

[22].   (5.12) Market equilibrium          C G                    Answer: a  EASY

Statement a is true, because if the expected return does not equal the required return, then markets are not in equilibrium.

 

[23].   (5.1) Preemptive right             C G                  Answer: c  MEDIUM

[24].   (5.2) Classified stock             C G                  Answer: d  MEDIUM

[25].   (5.6) Constant growth model        C G                  Answer: e  MEDIUM

Statement e is true, because the expected growth rate is also the expected capital gains yield.  All the other statements are false.

 

[26].   (5.6) Declining constant growth    C G                  Answer: d  MEDIUM

Note that P₀ = $2/(0.15 + 0.05) = $10.  That price is expected to decline by 5% each year, so P₁ must be $10(0.95) = $9.50.  Therefore, answer d is correct, while the others are all false.

 

[27].   (5.7) Constant growth stock        C G                  Answer: d  MEDIUM

Statement d is true, because the stock price is expected to grow at the dividend growth rate.

 

[28].   (5.7) Expected and required returns C G                  Answer: a  MEDIUM

The following calculations show that answer a is correct.  The others are all wrong.

 

A                         B 

Expected return                    10%                    12%

Expected growth                    7%                      9%

Dividend yield                       3%                      3%

 

[29].   (5.7) Expected and required returns C G                  Answer: d  MEDIUM

The following calculations show that answer d is correct.  The others are all wrong.

 

A                         B 

Price                                        $25                     $40

Expected growth                    7%                      9%

Expected return                    10%                    12%

A = P₀ = D₁/(r – g) = D₁=P₀(r) – P₀(g) = $0.75

B = P₀ = D₁/(r – g) = D₁=P₀(r) – P₀(g) = $1.20

 

[30].   (5.7) Expected and required returns C G                  Answer: e  MEDIUM

Statement e is correct, because if both stocks have the same price and the same required return, and A’s growth rate is twice that of B, then A’s dividend and dividend yield must be half that of B.  This point is illustrated with the following example.

 

  A                         B 

Price                                          $25                   $25

g                                                10%                    5%

r                                                 15%                  15%

Div. Yield = r – g  =                5%                  10%

D₁ = P(Div Yield) =            $1.25                $2.50

 

[31].   (5.7) Expected and required returns C G                  Answer: b  MEDIUM

The correct answer is statement b.  Both prices are currently the same, but X’s price should grow at 6% vs. 4% for Y, so X’s price should be higher a year from now.

 

[32].   (5.7) Expected and required returns C G                  Answer: a  MEDIUM

The correct answer choice is a.  One could quickly calculate the dividend yield and see that it equals the growth rate, but here are some numbers that provide more information.

 

D₁                 $3.00                D₁/P₀             6.0%

P₀               $50.00                r_X                 12.0%

g                    6.0%

 

[33].   (5.7) Expected and required returns C G                  Answer: a  MEDIUM

Dividend = Yield × Price:                  X dividend = $1.25             Y dividend = $0.75

 

Stock X has a dividend yield of 5% versus a yield of 3% for Y.  Since they both have the same stock price, X must pay a higher dividend.

 

[34].   (5.7) Expected and required returns C G                  Answer: c  MEDIUM

P₁ = P₀(1 + g) = $54.  Therefore, c is correct.  All the other answers are false.  P₁ = $54.00

 

[35].   (5.7) Dividend yield and g         C G                  Answer: e  MEDIUM

Statement e is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B’s, the growth rate for Stock A must be higher to offset this.

 

[36].   (5.7) Dividend yield and g         C G                  Answer: a  MEDIUM

[37].   (5.7) Dividend yield and g         C G                  Answer: e  MEDIUM

[38].   (5.11) Preferred stock concepts    C G                  Answer: a  MEDIUM

[39].   (5.11) Preferred stock concepts    C G                  Answer: a  MEDIUM

[40].   (5.12) Market equilibrium          C G                  Answer: d  MEDIUM

[41].   (Comp.) Common stock concepts      C G                  Answer: b  MEDIUM

Statement a is simply false.  Statement b is true.  Statements c and d are false, because the constant growth model can be used anytime as long as the constant growth rate is less than the required return (even if the growth rate is negative). Statement e is false—a number of companies have different classes of stock with different voting rights.

 

[42].   (Comp.) Common stock concepts      C G                  Answer: e  MEDIUM

Since X has the lower required return, if Y has a lower dividend yield it must have a higher expected growth rate.

 

[43].   (Comp.) Constant growth model: CAPM  C G                  Answer: a  MEDIUM

Statement a is true, because Stock A has a higher required return but the stocks have the same growth rate, so Stock A must have the higher dividend yield.  Here are some calculations to demonstrate the point.

 

     r_RF                          beta                        RP_M                        r_Stock   

A       6.40%         +           1.10           ×       6.00%         =        13.00%

B       6.40%         +           0.90           ×       6.00%         =        11.80%

 

        Div. Yld.                       g                           r_Stock   

A        D₁/P₀          +         7.00%         =       13.00%         D₁/P₀ = r – g = 6.00%

B        D₁/P₀          +         7.00%         =       11.80%         D₁/P₀ = r – g = 4.80%

 

[44].   (5.6) Constant growth valuation    C G                    Answer: c  EASY

D₁                                                 $0.75

r_s                                                  10.5%

g                                                    6.4%

P₀ = D₁/(r_s − g)                        $18.29

 

[45].   (5.6) Constant growth valuation    C G                    Answer: e  EASY

D₀                                                 $1.50

r_s                                                  10.1%

g                                                    4.0%

D₁ = D₀(1 + g) =                        $1.56

P₀ = D₁/(r_s − g)                        $25.57

 

 

[46].   (5.6) Constant growth valuation    C G                    Answer: d  EASY

Last dividend (D₀)                     $1.00

Long-run growth rate                5.4%

Required return                        11.4%

D₁ = D₀(1 + g) =                      $1.054

P₀ = D₁/(r_s − g)                        $17.57

[47].   (5.6) Constant growth rate         C G                    Answer: e  EASY

Expected dividend (D₁)                            $1.25

Stock price                                               $32.50

Required return                                        10.5%

Dividend yield                                          3.85%

Growth rate = r_s − D₁/P₀ =                     6.65%

 

[48].    (5.6) Constant growth: future price   C G                    Answer: e  EASY

Stock price                                               $35.50

Growth rate                                               5.50%

Years in the future                                            3

P₃ = P₀(1 + g)³ =                                      $41.69

 

[49].    (5.6) Constant growth: future price  C G                    Answer: e  EASY

Growth rate                                               4.75%

Years in the future                                            5

Stock price                                               $35.25

P₅ = P₀(1 + g)⁵ =                                      $44.46

 

[50].   (5.7) Expected dividend yield      C G                    Answer: d  EASY

D₁                                                 $1.25

g                                                    4.7%

P₀                                               $26.00

Dividend yield = D₁/P₀ =        4.81%

 

[51].   (5.7) Expected dividend yield      C G                    Answer: b  EASY

D₀                                                 $2.25

g                                                    3.5%

P₀                                               $50.00

D₁ = D₀(1 + g) =                      $2.329

Dividend yield = D₁/P₀ =        4.66%

 

[52].   (5.7) Expected cap. gains yield    C G                    Answer: a  EASY

D₁                                                 $1.50

g                                                    6.5%

P₀                                               $56.00

Capital gains yield = g =        6.50%

 

[53].   (5.7) Expected total return        C G                    Answer: e  EASY

D₁                                                                 $1.25

g                                                                    5.5%

P₀                                                               $44.00

Total return = r_s = D₁/P₀ + g                  8.34%

 

[54].   (5.7) Expected total return        C G                    Answer: e  EASY

D₀                                                                 $1.75

g                                                                    3.6%

P₀                                                               $32.00

D₁ = D₀(1 + g) =                                        $1.81

Total return = r_s = D₁/P₀ + g                  9.27%

 

[55].   (5.11) Preferred stock valuation   C G                    Answer: e  EASY

Preferred dividend                                    $7.50

Required return                                           6.5%

Preferred price = D_P/r_P =                     $115.38

 

[56].   (5.6) Constant g value: CAPM       C G                  Answer: a  MEDIUM

D₁                                                 $1.25

b                                                      1.15

r_RF                                               4.00%

RP_M                                            5.50%

g                                                  6.00%

r_s = r_RF + b(RP_M) =                10.33%

P₀ = D₁/(r_s − g)                        $28.90

 

[57].   (5.6) Constant g value: CAPM       C G                  Answer: a  MEDIUM

D₀                                                 $0.75

b                                                      1.15

r_RF                                                  4.0%

RP_M                                               5.0%

g                                                    5.5%

D₁ = D₀(1 + g) =                   $0.7913

r_s = r_RF + b(RP_M) =                  9.75%

P₀ = D₁/(r_s − g)                        $18.62

 

[58].   (5.6) Constant g value: CAPM       C G                  Answer: a  MEDIUM

D₀                                                                 $0.75

b                                                                      1.25

r_RF                                                                  4.5%

r_M                                                                10.5%

g                                                                    6.5%

D₁ = D₀(1 + g) =                                   $0.7988

r_s = r_RF + b(r_M − R_RF) =                           12.0%

P₀ = D₁/(r_s − g)                                        $14.52

 

[59].   (5.6) Constant growth dividend     C G                  Answer: b  MEDIUM

Stock price                                                               $25.00

Required return                                                      11.50%

Growth rate                                                               7.00%

P₀ = D₁/(r_s − g), so D₁ = P₀(r_s − g) =                 $1.1250

Last dividend = D₀ = D₁/(1 + g)                             $1.05

 

[60].   (5.6) Constant growth dividend     C G                  Answer: b  MEDIUM

Stock price                                                               $57.50

Required return                                                      10.25%

Growth rate                                                               6.00%

P₀ = D₁/(r_s − g), so D₁ = P₀(r_s − g)

Expected dividend = D₁ = P₀(r_s − g) =                  $2.44

 

[61].    (5.6) Constant growth: future price   C G                  Answer: a  MEDIUM

Next expected dividend = D₁ =                               $1.60

Required return                                                         11.0%

Dividend yield = D₁/P₀ =                                          6.0%

Find the growth rate: g = r_s − yield =                     5.0%

Find P₀ = D₁/(r_s − g) =                                           $26.67

Years in the future                                                            7

= P₀(1 + g)⁷                                                         $37.52

 

[62].   (5.11) Preferred required return   C G                  Answer: e  MEDIUM

Pref. quarterly dividend                                                           $1.00

Annual dividend = Qtrly dividend × 4 =                              $4.00

Preferred stock price                                                              $45.00

Nom. required return = Annual dividend/Price =              8.89%

 

[63].   (5.11) Preferred required return   C G                  Answer: e  MEDIUM

Periods per year =                                                                             4

Pref. quarterly dividend                                                           $1.00

Preferred stock price                                                              $55.00

Eff % required return = (1+ (Qt Div/P))^N − 1 =                 7.47%

 

[64].   (5.8) Nonconstant growth valuation   C G             Answer: d  MEDIUM/HARD

r_s = 9.0%

Year                                                      0                      1                      2                      3      

Growth rates:                                                          30.0%             10.0%              5.0%

Dividend                                           $1.32              $1.716            $1.888            $1.982

Terminal value = D₃/(r_s − g₃) =                                                    49.550

Total CFs                                                                  $1.716         $51.437

PV of CFs                                                                 $1.574         $43.294

 

Stock price = $44.87

 

[65].   (5.8) Nonconstant growth valuation   C G                    Answer: c  HARD

Last dividend (D₀)                                                     $1.25

Short-run growth rate                                                 25%

Long-run growth rate                                                    0%

Beta                                                                                1.20

Market risk premium                                              5.50%

Risk-free rate                                                            3.00%

Required return = r_s = r_RF + b(RP_M) =                  9.60%

 

Year                                                      0                      1                      2                      3                      4                      5      

25%                25%                25%                25%                 0%

Dividend                                           $1.2500          $1.5625          $1.9531          $2.4414          $3.0518          $3.0518

Terminal value = D₅/(r_s − g₅) =                                                                                                    31.7891

Total CFs                                                                  $1.5625          $1.9531          $2.4414       $34.8409

PV of the CFs                                                          $1.4256          $1.6260          $1.8544       $24.1461

 

Price = Sum of PVs = $29.05

 

[66].   (5.8) Nonconstant growth valuation   C G                    Answer: b  HARD

Last dividend (D₀)                                                     $1.75

Short-run growth rate                                                 25%

Long-run growth rate                                                    6%

Required return                                                            12%

 

Year                                                      0                      1                      2                      3      

25.00%          25.00%           6.00%

Dividend                                           $1.7500          $2.1875          $2.7344          $2.8984

Terminal value = D₃/(r_s − g₃) =                                                    48.3073

Total CFs                                                                  $2.1875       $51.0417

PV of CFs                                                                 $1.9531       $40.6901

 

Price = Sum of PVs = $42.64

 

[67].   (5.8) Nonconstant growth valuation   C G                    Answer: a  HARD

Last dividend (D₀)                                                     $1.55

Short-run growth rate                                              1.50%

Long-run growth rate                                              8.00%

Required return                                                      12.00%

 

Year                                                      0                      1                      2                      3        

1.50%             1.50%             8.00%

Dividend                                           $1.5500          $1.5733          $1.5968          $1.7246

Terminal value = D₃/(r_s − g₃) =                                                    43.1149

Total CFs                                                                  $1.5733       $44.7118

PV of CFs                                                                 $1.4047       $35.6439

 

Price = Sum of PVs = $37.05

 

[68].   (5.8) Nonconstant growth valuation   C G                    Answer: d  HARD

Required return                                                        11.0%

Short-run growth rate                                              15.0%

Long-run growth rate                                                6.0%

Last dividend (D₀)                                                     $1.25

 

Year                                                      0                      1                      2                      3                      4        

Dividend                                           $1.2500          $1.4375          $1.6531          $1.9011          $2.0152

Terminal value = P₃ = D₄/(r_s – g₄) =                                                                    40.3032

Total CFs                                                                  $1.4375          $1.6531       $42.2043

PV of CFs                                                                 $1.2950          $1.3417       $30.8594

 

Price = Sum of PVs = $33.50

 

[69].   (5.8) Nonconstant growth valuation   C G                    Answer: d  HARD

Required return = 11%

 

Year                                                      0                  1                  2                  3                  4                  5                  6      

50.00%      25.00%       8.00%

Dividend                                         $0.000        $0.000        $0.000        $0.250        $0.375        $0.469       $0.506

Terminal value = P₅ = D₆/(r_s − g₆) =                                                                                              16.875

Total CFs                                                            $0.000        $0.000        $0.250        $0.375      $17.344

PV of CFs                                                           $0.000        $0.000        $0.183        $0.247      $10.293

 

Price = $10.72

 

[70].   (5.8) Nonconstant growth rate*     C G               Answer: e  VERY HARD

Stock price                                                               $40.00

Paid dividend (D₀)                                                    $1.00

Short-run growth rate                                              30.0%

Required return                                                        12.0%

Forecasted LR growth rate, X                               6.34%    Arbitrarily set at 5% initially.

 

Year                                                      0                      1                      2                      3                      4                      5      

30.0%             30.0%             30.0%             30.0%             6.34%

Dividend                                           $1.0000          $1.3000          $1.6900          $2.1970          $2.8561          $3.0372

Terminal value = P₄ = D₅/(r_s − g₅):                                                                                              53.6777

Total CFs                                                                  $1.3000          $1.6900          $2.1970       $56.5338

PV of CFs                                                                 $1.1607          $1.3473          $1.5638       $35.9282

 

Stock price = $40.00  Must equal $40.  Change the forecasted growth rate till reach $40.

 

We must solve for the long-run growth rate.  We can forecast the dividends in Years 1-4, so they are inserted in the time line.  We need a growth rate to find D₅ and the TV.  We begin with a guess of say 5.0%, which we insert in the forecast cell.  We then find the PV of the forecasted CFs and sum them.  If the sum equals the given price, then our growth rate would be correct.  If not, we need to substitute in different g’s until we find the one that works.  We used Excel’s Goal Seek function to simplify the process, but one could use trial and error.

[71].   (5.8) Nonconstant value: Excel*    C G               Answer: d  VERY HARD

Finding the discount rate when we know the dividends and the actual stock price is complicated if the growth rate is not constant, and an iterative solution is required.

 

Estimated r_s =                                                         12.97%

Actual Market Price, P₀:                                        $15.00

                   Rapid Growth                                 Normal Growth     

Year                                                      0                      1                      2                      3                      4                      5      

4                                   5

Dividend growth rate                                             10%                10%                10%                  5%                  5%

Dividends (D₀ has been paid)       $1.00              $1.100            $1.210            $1.331            $1.398

TV₃ = P₃ = D₄/(r_s – g₄). Use Estimated r_s.                                                        $17.527

Total CFs                                                                  $1.100            $1.210         $18.858

PVs of CFs discounted at Estimated r_s               $0.974            $0.948         $13.078

 

Calculated Price = P₀ = Sum of PVs = $15.00