Introduction to Corporate Finance What Companies Do, 3rd Edition by John Graham - Test Bank

Introduction to Corporate Finance What Companies Do, 3rd Edition by John Graham – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

Chapter 5—Valuing Stocks

 

MULTIPLE CHOICE

 

1. The first public sale of company stock to outside investors is called a/an

a.	seasoned equity offering.
b.	shareholders’ meeting.
c.	initial public offering.
d.	proxy fight.

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

2. Which statement about common shareholders is incorrect?

a.	Shareholders only have a residual claim.
b.	Shareholders have precedence over all other claimholders in the case of bankruptcy.
c.	Shareholders have a voting right.
d.	Shareholders are the ultimate owners of a corporation.

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

3. What is the market capitalization of a company?

a.	The market value of all outstanding debt.
b.	The book value of the company’s debt.
c.	The market value of all outstanding shares.
d.	The book value of the company’s total equity.

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

4. Which of the following is not a difficulty associated with valuing common stock?

a.	Common stock does not have a specific expiration date.
b.	The required rate of return is difficult to estimate.
c.	Common stock does not promise a fixed cash flow stream.
d.	All of the above are considered difficulties associated with valuing common stock.

 

 

ANS:  D                    PTS:   1                    DIF:    E

REF:   5.2 Valuing Preferred and Common Stock                         NAT:  Reflective thinking

LOC:  understand stocks and bonds

 

5. Which of the following stock exchanges has the most strict listing requirements?

a.	American Stock Exchange
b.	NASDAQ
c.	New York Stock Exchange
d.	Pacific Stock Exchange

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

6. Bavarian Sausage, Inc. has preferred stock outstanding. This stock pays a semiannual dividend of $1.25. If the next dividend is paid six months from now and the annual required return is 10%, what should be the value of the preferred stock?

a.	$6.25
b.	$25
c.	$12.50
d.	$50.00

 

 

ANS:  B

1.25/(.10/2) = 25

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

7. Bavarian Sausage just paid a $1.57 dividend and investors expect that dividend to grow by 5% each year forever. If the required return on the stock investment is 14%, what should be the price of the stock today.

a.	$11.21
b.	$18.32
c.	$17.44
d.	$25.37

 

 

ANS:  B

1.57(1.05)/(.14-.05) = 18.32

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

8. Bavarian Sausage is expected to pay a $1.57 dividend next year and investors expect that dividend to grow by 5% each year forever. If the required return on the stock investment is 14%, what should be the price of the stock today.

a.	$18.32
b.	$17.44
c.	$11.21
d.	$25.37

 

 

ANS:  B

1.57/(.14-.05) = 17.44

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

9. Bavarian Sausage just paid a $1.57 dividend and investors expect that dividend to grow by 5% each year forever. If the required return on the stock investment is 14%, what should be the price of the stock in 5 years?

a.	$18.32
b.	$23.33
c.	$17.44
d.	$22.26

 

 

ANS:  B

D5 = 1.57^5 = 2.00

P5 = 2.00(1.05)/(.14-.05) = 23.33

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

10. Bavarian Sausage is expected to pay a $1.57 dividend next year and investors expect that dividend to grow by 5% each year forever. If the required return on the stock investment is 14%, what should be the price of the stock in 5 years?

a.	$18.32
b.	$22.28
c.	$21.22
d.	$17.44

 

 

ANS:  B

D5 = 1.57(1.05)^4 = 1.91

P5 = 1.91(1.05)/(.14-.05) = 22.28

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

11. Smith Construction, Inc. just paid a $2.78 dividend. The dividend is expected to grow by 4% each year for the next three years. After that the company will never pay another dividend ever again. If your required return on the stock investment is 10%, what should the stock sell for today?

a.	$7.46
b.	$28.91
c.	$46.33
d.	$15.63

 

 

ANS:  A

D1 = 2.78(1.04) = 2.89

D2 = 2.89(1.04) = 3.01

D3 = 3.01(1.04) = 3.13

P = 2.89/1.1 + 3.01/1.1^2 + 3.13^3 = 7.46

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

12. Smith Construction, Inc. is expected to pay a $2.78 dividend next year. The dividend is expected to grow by 4% each year for the next three years. After that the company will never pay another dividend ever again. If your required return on the stock investment is 10%, what should the stock sell for today?

a.	$7.46
b.	$28.91
c.	$35.06
d.	$9.31

 

 

ANS:  D

D1 = 2.78

D2 = 2.78(1.04) = 2.89

D3 = 2.89(1.04) = 3.01

D4 = 3.01(1.04) = 3.13

P = 2.78/1.1 + 2.89/1.1^2 + 3.01/1.1^3 + 3.13/1.1^4 = 9.31

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

13. Miller Juice, Inc. is not paying a dividend right now, but is expected to pay a $4.56 dividend two years from now. Investors expect that dividend to grow by 4% every year forever. If the required return on the stock investment is 14%, what should be the price of Miller Juice stock today?

a.	$53.69
b.	$36.49
c.	$47.42
d.	$43.84

 

 

ANS:  B

P2 = 4.56(1.04)/(.14-.04) = 47.42

P = (4.56+47.42)/1.14^2 = 36.49

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

14. Miller Juice, Inc. just paid a $3 dividend. The company is expected to pay a $3.50 dividend next year and a $4 dividend in two years. After that, dividends are expected to grow at 5% forever. If investors require a return of 12% on the investment, what should Miller Juice stock sell for today?

a.	$54.15
b.	$49.63
c.	$57.15
d.	$60.00

 

 

ANS:  A

P2 = 4(1.05)/(.12-.05) = 60

P = 3.5/1.12 + (4+60)/1.12^2 = 54.15

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

15. Miller Juice, Inc. is expected to pay a $3.00 dividend next year and a $4 dividend in two years. After that, dividends are expected to grow at 5% forever. If investors require a return of 12% on the investment, what should Miller Juice stock sell for today?

a.	$60.00
b.	$54.15
c.	$49.39
d.	$53.70

 

 

ANS:  D

P2 = 4(1.05)/(.12-.05) = 60

P = 3/1.12 + (60+4)/1.12^2 = 53.70

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

16. Miller Juice traditionally pays out 35% of its earnings as dividends. Last year Miller’s earnings available for common stockholders were $256 million and the book value of its equity was $678 million. What is Miller’s growth rate?

a.	24.54%
b.	35.00%
c.	37.76%
d.	13.22%

 

 

ANS:  A

(256/678)(1-.35) = .2454

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

17. Miller Juice traditionally retains 65% of its earnings for future investments. Last year Miller’s return on equity was 15%. What is Miller’s growth rate?

a.	15.00%
b.	9.75%
c.	5.25%
d.	18.38%

 

 

ANS:  B

.15(.65) = .0975

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

18. Bavarian Sausage free cash flow for the current year is $6,750,000 and investors believe that the company’s free cash flow will grow by 5% annually forever. If Bavarian sausage’s weighted average cost of capital is 15%, what is their enterprise value?

a.	$67,500,000
b.	$85,350,000
c.	$56,780,000
d.	$70,875,000

 

 

ANS:  B

6750000(1.05)/(.15-.05) = 85350000

 

PTS:   1                    DIF:    E

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

19. Bavarian Sausage’s enterprise value is $75,000,000, the market value of its debt is $23,000,000 and the company does not have any preferred stock outstanding. If the company has 3,500,000 shares outstanding, what should be Bavarian Sausage’s stock price?

a.	$21.43
b.	$14.86
c.	$28.00
d.	$6.57

 

 

ANS:  C

(75000000-23000000)/3500000 = 14.86

 

PTS:   1                    DIF:    E

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

20. Bavarian Sausage’s enterprise value is $75,000,000, the market value of its debt is $23,000,000 and the market value of its preferred stock is $5,000,000. If the company has 3,500,000 shares outstanding, what should be Bavarian Sausage’s stock price?

a.	$14.86
b.	$21.43
c.	$13.43
d.	$6.57

 

 

ANS:  C

(75000000-23000000-5000000)/3500000 = 13.43

 

PTS:   1                    DIF:    M

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

21. Bavarian Sausage is expected to pay a $1.57 dividend next year. If the required return on the stock investment is 14%, and the stock currently sells for $34.37, what is the implied dividend growth rate for this company?

a.	6.37%
b.	9.43%
c.	12.68%
d.	15.76%

 

 

ANS:  B

34.37 = 1.57/(.14-g)

 

g = .0943

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

22. Bavarian Sausage just paid a $1.57 dividend. If the required return on the stock investment is 14%, and the stock currently sells for $34.37, what is the implied dividend growth rate for this company?

a.	9.02%
b.	6.39%
c.	12.68%
d.	9.43%

 

 

ANS:  A

34.37 = 1.57(1+g)/(.14-g)

g = .0902

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

NARRBEGIN: Miller Juice

Miller Juice

Miller Juice is a young company that currently does not pay a dividend. The company retains all their earnings to finance their growth. However, ten years from now the company is expected to start paying a $1.50 dividend. According to research reports the dividend should then grow by 5% annually forever.

NARREND

 

 

23. If the required return on the stock investment is 13%, what should be Miller’s stock price today?

a.	$19.69
b.	$6.24
c.	$15.62
d.	$10.37

 

 

ANS:  B

P10 = 1.5(1.05)/(.13-.05) = 19.69

 

P = (1.5+19.69)/(1.13)^10 = 6.24

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

24. If the required return on the stock investment is 13%, what should be Miller’s stock price five years from today?

a.	$11.50
b.	$6.24
c.	$19.69
d.	$16.28

 

 

ANS:  A

P10 = 1.50(1.05)/(.13-.05) = 19.69

P5 = (1.5 + 19.69)/(1.13)^5 = 11.50

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

25. If the required return on the stock investment is 13%, what should be Miller’s stock price immediately after the first dividend was paid?

a.	$6.24
b.	$19.69
c.	$16.28
d.	$21.19

 

 

ANS:  B

P10 = 1.50(1.05)/(.13-.05) = 19.69

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

26. Which of the following investors can force a firm into bankruptcy court if the firm does not pay the expected cash flow to the investor?

a.	common equity investor
b.	preferred equity investor
c.	debt investor
d.	none of the above

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

27. Which of the following securities poses the greatest financial risk for the investor?

a.	common equity
b.	preferred equity
c.	debt
d.	convertible debt

 

 

ANS:  A                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  acquire an understanding of risk and return

 

28. MeFirst Corporation has a cumulative preferred share issue that is suppose to pay a quarterly dividend of $2. MeFirst failed to pay 3 consecutive dividends to investors and then managed to pay a common share dividend the very next quarter. How much cash must MeFirst have paid to each preferred share holder at that time?

a.	$2 per share
b.	$6 per share
c.	$8 per share
d.	$10 per share

 

 

ANS:  C                    PTS:   1                    DIF:    M

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

29. Retained earnings represents

a.	a pool of cash that the firm can use should a need for cash arise.
b.	the increased market value, due to managements efforts, of all of the firms equity securities issued.
c.	earnings that a firm reinvested during the firm’s history.
d.	the cumulative amount of cash that the firm has paid out in dividends.

 

 

ANS:  C                    PTS:   1                    DIF:    M

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking

LOC:  acquire knowledge of financial analysis and cash flows

 

30. Usually, only the riskiest type of firms will offer securities to the general public through

a.	a firm-commitment offering.
b.	a competitive offering.
c.	a negotiated offering.
d.	a best-efforts arrangement.

 

 

ANS:  D                    PTS:   1                    DIF:    M

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

31. Which of the following is not the responsibility of the lead underwriter for an equity issuance?

a.	price stabilization of the issue
b.	exercises discretion over the distribution of shares for sale among the syndicate and the selling group
c.	must buy the shares in the green shoe option
d.	many times serves as the market maker for trading in the issuers securities

 

 

ANS:  C                    PTS:   1                    DIF:    M

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

32. Which of the following is not an important consideration when an underwriter is trying to establish the price for an initial public offering?

a.	the underwriter’s reputation
b.	the value of the firm
c.	the demand for the securities of the issuer
d.	providing the absolute maximum price possible for the issuer of the shares

 

 

ANS:  D                    PTS:   1                    DIF:    H

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

33. The vast majority of initial public offerings have underwriting spreads that cost the firm what percentage of the net capital raised?

a.	0.5%
b.	7.0%
c.	7.5%
d.	8.0%

 

 

ANS:  C

The firm will net 93 out of each 100 dollars raised. Therefore, the cost to the firm is 7/93 = .075

 

PTS:   1                    DIF:    H

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

34. The Over-the-Counter Market for trading equity securities is located

a.	in New York City.
b.	in Chicago.
c.	in Boston.
d.	none of the above

 

 

ANS:  D                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

35. The largest stock exchange in the world is

a.	the London Stock Exchange.
b.	the New York Stock Exchange.
c.	the NASDAQ.
d.	the Paris Bourse.

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

36. If viewing a stock quote from the Wall Street Journal, the columns labeled “HI” and “LO” refer to

a.	the highest and lowest prices at which the stock was sold in the last fifty-two weeks.
b.	the highest and lowest prices at which the stock was sold in the last six months.
c.	the highest and lowest prices at which the stock was sold in the last month.
d.	the highest and lowest prices at which the stock was purchased in the last month.

 

 

ANS:  A                    PTS:   1                    DIF:    M

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

37. When valuing a preferred stock, the type of security that we treat the preferred stock like, for valuation purposes, is

a.	a bond.
b.	a perpetuity.
c.	a common stock.
d.	none of the above.

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.2 Valuing Preferred and Common Stock                         NAT:  Reflective thinking

LOC:  understand stocks and bonds

 

38. AlwaysAround Co. has just issued a preferred stock that pays an annual $4 dividend. The first dividend will be received one year from today. If the required rate of return on this stock is 5%, then what is the price of the stock?

a.	$3.81
b.	$4.20
c.	$80.00
d.	none of the above

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.2 Valuing Preferred and Common Stock                         NAT:  Analytic skills

LOC:  understand stocks and bonds

 

39. The Perp, Inc. has a preferred stock that will pay its next annual $5 dividend one year from now. The current price of the stock is $110. What is the required rate of return on the stock?

a.	4.55%
b.	4.00%
c.	5.50%
d.	22.00%

 

 

ANS:  A

110 = 5/r ===> r = .04545

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

40. You are approached about purchasing a share of common stock in a company that will definitely go out of business exactly 2 years from today. The company is anticipated to pay a $10 dividend one year from now and a $15 dividend two years from now (immediately before it goes out of business). What price are you willing to pay for the stock if the required rate of return on the stock is 5%?

a.	$22.68
b.	$23.13
c.	$23.81
d.	$25.00

 

 

ANS:  B

10/1.05 + 15/ (1.05)² = 23.13

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

41. Static Utility Company anticipates its revenues, and consequently its common stock dividends, will remain flat forever. It currently pays an annual dividend of $20 per year. If it pays the next dividend exactly one year from today, then what is the price of Static’s common shares if the required rate of return is 12%?

a.	$24.00
b.	$40.00
c.	$166.67
d.	$200.00

 

 

ANS:  C

20/.12 = 166.66666

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

42. ConsGrough, Inc. has increased its annual common dividend by 3% in each of the years that the company has existed. If you believe that the company can continue to do so indefinitely, then what price would you be will to pay for ConsGrough if the required rate of return is 6% and the dividend that it paid yesterday was $5?

a.	$85.83
b.	$166.67
c.	$171.67
d.	$200.00

 

 

ANS:  C

(5 ´ 1.03)/(.06 – .03)

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

43. ConsGrough, Inc. has increased its annual common dividend by 3% in each of the years that the company has existed. If you believe that the company can continue to do so indefinitely, then what is the required rate of return if the price of ConsGrough is $171.67 and the dividend that it paid yesterday was $5?

a.	.029
b.	.03
c.	.06
d.	none of the above

 

 

ANS:  C

171.67 = (5 ´ 1.03) / (r – .03) =======> r = .06

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

44. Predictable Corp has increased its annual dividend each year of its life by 2% (and will continue to do so indefinitely). If Predictable paid its annual dividend yesterday of $8 and the cost of capital is currently 4%, then by what amount will the stock price decrease by if the cost of capital increases to 5%?

a.	$408.00
b.	$272.00
c.	$136.00
d.	none of the above

 

 

ANS:  C

Now: (8 ´ 1.02) / (.04-.02) = 408.00

 

Later: (8 ´ 1.02) / (.05-.02) = 272.00

 

Decrease = 408 – 272 = 136

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

45. You are asked by the Chief Financial Officer of your firm to predict what the firm’s stock price will be exactly 4 years from today. If your firm is expected to grow at 3% indefinitely and the cost of capital is 10% while the expected annual dividend one year from today is $10, then what should be the price of your firm’s stock 4 years from today?

a.	$142.86
b.	$160.79
c.	$112.55
d.	none of the above

 

 

ANS:  B

P4 = (D₁ ´ (1+g)⁴) / (r – g)

 

P4 = (10 ´ (1.03)⁴) / (.1 – .03) = 160.79

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

46. Last year Sample Corp. had earnings of $3 a share based upon a common share book value of $25 per share. If Sample paid a dividend of $1.50 last year then estimate Sample’s growth rate.

a.	6%
b.	12%
c.	50%
d.	none of the above

 

 

ANS:  A

g = rr ´ ROE = (1.5/3) ´ (3/25) = .06

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

47. Balance Corp. has a weighted average cost of capital equal to 5.5%. If the firm is financed with 25% equity and 75% debt and if the after-tax of that debt is 4%, then what is the cost of equity for the firm?

a.	.025
b.	.06
c.	.1
d.	none of the above

 

 

ANS:  C

(.25)(cost of equity) + (.75)(.04) = .055 =====> cost of equity = .1

 

PTS:   1                    DIF:    M

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of capital budgeting and the cost of capital

 

48. Borrower Corp. has the ability to produce $4,000,000 of free cash flow next year and expects that to grow by 2% per year thereafter. If Borrower’s weighted average cost of capital is 13%, then what is the value of Borrower?

a.	$40,000,000.00
b.	$30,769,230.77
c.	$36,363,636.36
d.	none of the above

 

 

ANS:  C

4,000,000 / (.13 – .02) = 36,363,636.36

 

PTS:   1                    DIF:    M

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

49. Equal, Inc. is financed with equal portions of debt and equity. The after-tax cost of debt is 6% and the cost of equity is 8%. If Equal expects next year’s free cash flow to be $25,000,000 with growth of 3% thereafter, what is the value of Equal, Inc. to the nearest dollar? Equal’s marginal tax rate is 35%.

a.	$357,142,857
b.	$625,000,000
c.	$833,333,333
d.	none of the above

 

 

ANS:  B

WACC: (.5)(.08) + (.5)(.06) = .07

 

Value = 25,000,000/(.07 – .03) = 625,000,000

 

PTS:   1                    DIF:    M

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

50. Undetermined Corporation currently has a 10% weighted average cost of capital. It is concerned that its after-tax cost of debt will increase in the near future by 2%. If Undetermined finances its projects with 30% debt, then what will the new weighted average cost of capital for Undetermined be?

a.	12.0%
b.	13. %
c.	10.6%
d.	none of the above

 

 

ANS:  C

.10 + (.3)(.02) = .106

 

PTS:   1                    DIF:    M

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of capital budgeting and the cost of capital

 

51. Which is TRUE concerning preferred stock?

a.	Preferred stock is considered debt on the company balance sheet.
b.	Preferred stock holders have voting rights for the company board of directors.
c.	Preferred stock payments are variable like common stock.
d.	Preferred stock is viewed as less risky than a firm’s common stock.

 

 

ANS:  D                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

NARRBEGIN: Kramerica, Inc.

Kramerica, Inc.

Kramerica Inc. just paid its investors a dividend of $2.00. This growing company expects dividends to grow at 20% for the next 2 years. After year 2, dividends are expected to grow constantly at 5% per year. Investors require a 15% return on Kramerica stock.

NARREND

 

 

52. What will be the dividend in two years for Kramerica?

a.	$2.21
b.	$2.40
c.	$2.52
d.	$2.88

 

 

ANS:  D

Dividend in year 2 = $2.00*1.20*1.20= $2.88

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

53. What is the equation to price Kramerica stock?

a.	P0
b.	P0
c.	P0
d.	P0

 

 

ANS:  D

Selling price at year 2 = $2.00*(1.20)^2*(1.05)/(.15-.05)= $30.24

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

NARRBEGIN: ABC Corp.

ABC Corporation

ABC Corporation just paid a dividend of $1.50 a share. The dividend is expected to grow at 10% a year for the next 2 years, and the 5% per year thereafter. The required return to invest in ABC stock is 12.50%.

NARREND

 

 

54. What is the expected dividend for ABC in year 2?

a.	$1.65
b.	$1.73
c.	$1.82
d.	$1.91

 

 

ANS:  C

Dividend in year 2 = $1.50*1.10*1.10 = $1.82

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

55. What is the intrinsic value (or current price) of ABC?

a.	$21.00
b.	$22.98
c.	$23.41
d.	$24.48

 

 

ANS:  B

Dividend in year 2 = $1.50*1.10*1.10 = $1.82

Selling price at year 2 = $1.82 * 1.05 / (.125 – .05) = $25.41

 

Price = PV of cash flows = 1.65/1.125 + (1.82+25.41)/(1.125)^2

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

56. Suppose you want to buy ABC and hold it for the next 4 years. What would the selling price be for ABC in 4 years, assuming that none of our assumptions change?

a.	$28.01
b.	$28.76
c.	$29.40
d.	$30.80

 

 

ANS:  A

Dividend in year 2 = $1.50*1.10*1.10 = $1.82

Dividend in year 4 = $1.50*1.10*1.10*1.05*1.05 =$2.00

Selling price at year 4 = $2.00 * 1.05 / (.125 – .05) = $28.01

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

57. A stock just paid a $2.00 dividend this morning. You believe that dividends will grow constantly starting today at a rate of 5% per year. If you require a 10% to own this stock, what is a fair price to pay for the stock?

a.	$40.00
b.	$41.00
c.	$42.00
d.	$43.00

 

 

ANS:  C

=$2*1.05/(.1-.05) = $42.00

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

58. Suppose that you estimate D₁=$0.72, D₂=$0.76, D₃=$0.84, and D₄=$0.88 for a stock. You also estimate that, beginning at year 4, dividends will grow continually at a rate of 2% per year. If the required return to hold the stock is 14.6%, what is the stock’s current price?

a.	$6.20
b.	$6.25
c.	$6.30
d.	$6.40

 

 

ANS:  D

Selling price at year 4 = $0.88*1.02/(.146-02) = $7.12

 

Price = $.72/1.146 + $.76/(1.146)^2 + $.84/(1.146)^3 + $8.00/(1.146)^4

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

59. Suppose you plan on buying a stock today and holding it for one year. The stock will pay you a dividend EXACTLY in one year on the day you will sell. You believe the selling price in one year will be $27.10, while the stock will also pay a dividend of $2.40 in one year. If you require 16.60% return to invest in the stock, what is a fair price to pay today?

a.	$25.50
b.	$25.30
c.	$23.24
d.	$21.18

 

 

ANS:  B

Price = (27.10+2.40)/(1.166) = $25.30

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

NARRBEGIN: Bulldog Industries

Bulldog Industries

An analyst seeks to determine the value of Bulldog Industries. After careful research, the analyst believes that free cash flows for the firm will be $80 million in 2004 and will grow at 10% for 2005 and 2006. The free cash flows will grow at a rate of 5% after 2006.

NARREND

 

 

60. If Bulldog Industries has a weighted average cost of capital of 10%, find the market value of the firm. (assume that we are at January 1, 2004)

a.	$2,085.26
b.	$1,946.52
c.	$1,745.45
d.	$1,665.45

 

 

ANS:  C

FCF 2005 = $80*1.10 = $88

FCF 2006 = $88 * 1.10 = $96.80

TV = $96.80 * 1.05 / (.1-.05) = $2,032.80

 

MV of FIRM = $80/1.10 + $88/(1.10)^2 + ($96.80+$2,032.80)/(1.10)^3

 

PTS:   1                    DIF:    H

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

61. The market value of Bulldog Industries debt and preferred stock is $934 million. If the firm has a weighted average cost of capital of 10%, find the equity value of the firm’s stock. The firm has 50 million shares of stock outstanding. (assume that we are at January 1, 2004…)

a.	$14.63
b.	$16.23
c.	$17.03
d.	$22.63

 

 

ANS:  B

FCF 2005 = $80*1.10 = $88

FCF 2006 = $88 * 1.10 = $96.80

TV = $96.80 * 1.05 / (.1-.05) = $2,032.80

 

MV of FIRM = $80/1.10 + $88/(1.10)^2 + ($96.80+$2,032.80)/(1.10)^3 = $1,745.45

 

Equity value = $1,745.45 – $934 = $811.45

Per share = $811.45/50 =$16.23

 

PTS:   1                    DIF:    H

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

62. A firm plans on paying a constant dividend of $2 per share into the foreseeable future. If investors seek a 12% return to hold the firm’s stock, what is fair value for the company’s stock?

a.	$13.67
b.	$15.67
c.	$16.67
d.	$18.67

 

 

ANS:  C

=$2/.12

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

63. Which is NOT a feature of common stock?

a.	Voting rights
b.	Priority over debt holders for liquidation rights
c.	Rights to dividends and other distributions
d.	Majority voting system

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

64. After careful research, you find the present value of the free cash flows of a firm to be $100 million. The market value of the firm’s preferred stock is $15 million, while the market value of the firm’s debt is $40 million. If the firm has 2 million shares of stock outstanding, what is the equity value per share?

a.	$20.00
b.	$22.50
c.	$27.50
d.	$30.00

 

 

ANS:  B

Equity value per share = ($100 – $15 – $40)/2 =$22.5

 

PTS:   1                    DIF:    E

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

65. You estimate the following cash flows for Nick’s Incorporated: D₁=$0.83, D₂=$0.87, D₃=$0.96, and P₃=$27.40. If the required return to hold Nick’s stock is 15.1%, what is the price today for Nick’s stock?

a.	$18.31
b.	$18.85
c.	$19.98
d.	$20.35

 

 

ANS:  C

Price = $.83/1.151 + $.87/(1.151)^2 + ($0.96+$27.40)/(1.151)^3

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

66. What term refers to the number of shares issued by a firm multiplied by the current price of the shares on the secondary market?

a.	Financial leverage
b.	Market capitalization
c.	Additional paid-in capital
d.	Liquidation value

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

67. What is the term applied to several investment banks joining together to bring an IPO to market to limit risk exposure?

a.	Selling group
b.	Underwriting portfolio
c.	Investment bank portfolio
d.	Underwriting syndicate

 

 

ANS:  D                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

68. What is the largest (trading volume) over-the-counter (OTC) market in the United States?

a.	AMEX
b.	NYSE
c.	Nasdaq
d.	Chicago Board of Trade

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

69. An investor bought a stock this morning for $50, and plans to sell the stock one year from today. The investor believes the stock will pay a $1 dividend during the next year, and that the stock can be sold for $53 in one year. Given the investor’s beliefs, what is the return from investing in this stock for the next year?

a.	4%
b.	6%
c.	8%
d.	10%

 

 

ANS:  C

Return = ($53-$50 + $1)/ $50

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  acquire an understanding of risk and return

 

70. A share of preferred stock pays a $2 annual dividend, but pays the dividend in four equal quarterly installments. Investors seek a 12% annual percentage return on the investment. What price should the preferred stock trade?

a.	$4.17
b.	$6.67
c.	$8.50
d.	$16.67

 

 

ANS:  D

=$0.50/3%

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

71. Stone Cold Incorporated reported net income of $10 million for 2003. In addition, shareholder equity for the firm was $80 million at the end of 2003. The company was able to pay $3 million out as dividends to the shareholders for 2003. After 2003, excess paid-in-capital was $60 million. Given this information, what is the growth rate available for Stone Cold?

a.	3.75%
b.	5.00%
c.	7.50%
d.	8.75%

 

 

ANS:  D

ROE = $10/$80 = .125

rr = 1 – ($3/$10) = .70

 

Growth = .7*.125

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

72. For a stock pricing model, an analyst selects 10% as the sustainable growth rate in dividends for a firm. Given that the firm pays out 40% of net income as dividends each year, what is the return on shareholder equity for this firm?

a.	2.50%
b.	4.00%
c.	10.00%
d.	16.67%

 

 

ANS:  D

g = .10

rr = .60

g = rr*ROE

ROE = .1/.6

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

73. A stock is expected to pay a dividend of $3.00 in one year. To purchase the stock, investors seek a 15% annual return. If the stock is currently trading at $60, what is the implied constant growth rate in dividends for the future?

a.	5%
b.	10%
c.	15%
d.	20%

 

 

ANS:  B

$60 = $3/(.15-g)

.15-g = $3/$60

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analytic skills                                 LOC:  understand stocks and bonds

 

NARRBEGIN: Normaltown Corporation

Normaltown Corporation

An analyst has predicted the free cash flows for Normaltown Corporation for the next four years:

 

YEAR	FCF
2004	$10 million
2005	$15 million
2006	$22 million
2007	$29 million

 

NARREND

 

 

74. After 2007, the free cash flows are expected to grow at an annual rate of 5%. If the weighted average cost of capital is 12% for Normaltown, find the enterprise value of the firm.

a.	$54.98 million
b.	$301.81 million
c.	$313.00 million
d.	$331.43 million

 

 

ANS:  D

Terminal value = $29*1.05/(.12-.05) = $435

PV of cash flows = $10/1.12 + $15/(1.12)^2 + $22/(1.12)^3 + $464/(1.12)^3 = $331.43

 

PTS:   1                    DIF:    H

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

75. After 2007, the free cash flows are expected to grow at an annual rate of 5%. The weighted average cost of capital for Normaltown is 12%. If the market value of the firm’s debt is $100 million, find the value of the firm’s equity.

a.	$201.81 million
b.	$213.00 million
c.	$231.43 million
d.	$271.20 million

 

 

ANS:  C

Terminal value = $29*1.05/(.12-.05) = $435

PV of cash flows = $10/1.12 + $15/(1.12)^2 + $22/(1.12)^3 + $464/(1.12)^3 = $331.43

 

Equity value = $331.43 – $100

 

PTS:   1                    DIF:    H

REF:   5.3 The Free Cash Flow Approach to Com Stock Value     NAT:  Analytic skills

LOC:  acquire knowledge of financial analysis and cash flows

 

76. Debt holders:

a.	are the residual owners of a corporation.
b.	have little say in how the firm conducts its business.
c.	cannot force the firm into bankruptcy court if it fails to make the scheduled interest and principal payments on time.
d.	are willing to accept more risk than the stockholders in the corporation.

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

77. Stockholder voting rights include:

a.	voting on the amount of dividends the firm will pay to current stockholders.
b.	voting as to whether or not the firm should file for bankruptcy.
c.	voting for members on the Board of Directors.
d.	voting on whether or not the firm will issue additional debt.
e.	all of the above

 

 

ANS:  C                    PTS:   1                    DIF:    H

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

78. Which of the following statements is false?

a.	Dual-class stock is more prevalent in the United States than it is in other countries.
b.	When a corporation has dual-class stock, the corporate insiders generally concentrate their holdings in the superior voting-share class, while ordinary investors tend to hold relatively more of the inferior voting-class stock.
c.	One purpose of a dual-class structure is to allow insiders to raise the capital needed to finance growth without losing voting control.
d.	All of the above statements are false.
e.	Only statements (a) and (b) are false.

 

 

ANS:  A                    PTS:   1                    DIF:    M

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

79. The decision as to whether or not a firm will pay dividends is explicitly made by the:

a.	stockholders
b.	bondholders
c.	Board of Directors
d.	Chief Financial Officer
e.	Chief Executive Officer

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.1 The Essential Features of Preferred and Common Stock

NAT:  Reflective thinking                          LOC:  understand stocks and bonds

 

80. Which of the following activities is not one of the three principal lines of business for U.S.-based investment banks?

a.	Working capital management
b.	Corporate finance
c.	Trading
d.	Asset management

 

 

ANS:  A                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  understand the role of the finance function in the enterprise

 

81. One of the most time-consuming aspects of preparing for an equity offering is:

a.	preparing the necessary documents for filing with regulators.
b.	putting on the road show so that managers can pitch their business plan to prospective investors.
c.	oversubscribing the offering.
d.	none of the above

 

 

ANS:  A                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

82. A Green Shoe option is:

a.	the option of the issuing firm to buy back stock from a select group of stockholders.
b.	the option to sell more shares than were originally planned.
c.	the option to use a selling group to distribute shares of stock.
d.	the option to sell fewer shares than were originally planned.

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

83. When evaluating the secondary market based upon how the securities are traded, we can divide the market into two segments:

a.	a bull market and a bear market.
b.	a stock market and a bond market.
c.	a primary market and a secondary market.
d.	a broker market and a dealer market.

 

 

ANS:  D                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

84. A “dealer market” is:

a.	when buyers and sellers contact each other directly to arrange an exchange of securities.
b.	a market in which the buyer and seller are not brought together directly but, rather, have their orders executed by securities dealers.
c.	a market in which buyers and sellers are brought together on a securities exchange to trade securities.
d.	none of the above

 

 

ANS:  B                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

85. A “broker market” is:

a.	when buyers and sellers contact each other directly to arrange an exchange of securities.
b.	a market in which the buyer and seller are not brought together directly but, rather, have their orders executed by securities dealers.
c.	a market in which buyers and sellers are brought together on a securities exchange to trade securities.
d.	none of the above

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

86. Which of the following would NOT fall under the classification of a broker market?

a.	New York Stock Exchange
b.	American Stock Exchange
c.	NASDAQ
d.	All of the above are classified as broker markets

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

87. Pink Sheets refer to:

a.	the confirmation notice an investor receives notifying them that their transaction has occurred.
b.	the unregulated section of the market where companies are not required to file with the SEC.
c.	an electronic quotation system linking the market makers that trade the shares of small companies that is regulated by the SEC.
d.	the biggest dealer market that uses an electronic trading system to facilitate dealer transactions.
e.	none of the above

 

 

ANS:  B                    PTS:   1                    DIF:    M

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

88. What is the term that represents the abbreviation used to identify a company when its stock price is being quoted?

a.	CUSIP
b.	Ticker tape
c.	Ticker symbol
d.	none of the above

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.5 Primary and Secondary Markets For Equity Sec           NAT:  Reflective thinking

LOC:  acquire knowledge of financial markets and interest rates

 

89. For the zero growth model:

a.	because the valuation formula reduces to the equation for the present value of a perpetuity the process is essentially the same for valuing preferred stock.
b.	because the valuation formula reduces to the equation for the future value of a perpetuity the process is essentially the same for valuing preferred stock
c.	because the valuation formula reduces to the equation for the present value of an ordinary annuity, the process is essentially the same for valuing preferred stock.
d.	because the valuation formula reduces to the equation for the future value of an ordinary annuity, the process is essentially the same for valuing preferred stock.

 

 

ANS:  A                    PTS:   1                    DIF:    M

REF:   5.2 Valuing Preferred and Common Stock                         NAT:  Reflective thinking

LOC:  understand stocks and bonds

 

90. When determining the stock price if a firm never plans to pay a dividend:

a.	then it cannot have value
b.	then there must be an expectation that the firm will distribute cash to the investors at some point in the future
c.	a very precise process is used that requires little in terms of future estimates of cash flows
d.	all of the above
e.	none of the above

 

 

ANS:  B                    PTS:   1                    DIF:    M

REF:   5.2 Valuing Preferred and Common Stock                         NAT:  Reflective thinking

LOC:  understand stocks and bonds

 

91. ____ represents the amount of cash that would remain if a firm’s assets were sold and all liabilities were paid.

a.	book value
b.	market value
c.	liquidation value
d.	present value
e.	none of the above

 

 

ANS:  C                    PTS:   1                    DIF:    E

REF:   5.4 Other Approaches to Common Stock Valuation            NAT:  Reflective thinking

LOC:  acquire knowledge of financial analysis and cash flows

 

92. ____ represents the value of a firm’s equity shown on its balance sheet.

a.	book value
b.	market value
c.	liquidation value
d.	present value
e.	none of the above

 

 

ANS:  A                    PTS:   1                    DIF:    E

REF:   5.4 Other Approaches to Common Stock Valuation            NAT:  Reflective thinking

LOC:  acquire knowledge of financial analysis and cash flows

 

93. Which of the following statements is false?

a.	P/E ratios are widely reported in the financial press and they are very easy to interpret.
b.	As the value of the dividend growth rate rises, the P/E ratio falls.
c.	A firm with a higher P/E ratio always has greater growth prospects than a firm with a lower P/E ratio.
d.	All of the above statements are false.
e.	Only (b) and (c) are false

 

 

ANS:  D                    PTS:   1                    DIF:    M

REF:   5.4 Other Approaches to Common Stock Valuation            NAT:  Reflective thinking

LOC:  understand stocks and bonds

 

94. Zeb Corporation just paid a dividend of 3.11 and has an expected growth rate of 12% for the foreseeable future, if the discount rate is 18% what is the appropriate stock price today?

 

a.	$58.05
b.	$51.83
c.	$57.87
d.	$55.06

 

 

ANS:  A

g=	0.12
D0=	3.11
D1=	3.48
r=	0.18
P0=	D1/(r-g)
P0=	58.05

 

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

95. Monte Corporation just paid a dividend of $4.25 and has an expected growth rate of 15% for the foreseeable future, if the discount rate is 18% what is the appropriate stock price today?

a.	$141.67
b.	$162.92
c.	$162.74
d.	$146.07

 

 

ANS:  B

g=  0.15

D₀=  4.25

D₁=  4.89

r=  0.18

P₀=  D₁/(r-g)

P₀=  162.92

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

96. Zuma Corporation just paid a dividend of $5.23 and has an expected growth rate of 5% for the foreseeable future, if the discount rate is 17% what is the appropriate stock price today?

a.	$43.58
b.	$45.59
c.	$45.76
d.	$48.86

 

 

ANS:  C

g=  0.05

D₀=  5.23

D₁=  5.49

r=  0.17

P₀=  D₁/(r-g)

P₀=  45.76

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

97. Ajax Corporation just paid a dividend of $5.23 and has an expected growth rate of 5% for the foreseeable future, if the discount rate is 17% what is the appropriate stock price today?

a.	$49.20
b.	$51.34
c.	$50.48
d.	Cannot be determined with the available information

 

 

ANS:  C

Dividing by zero

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

98. Declining Corporation just paid a dividend of $1.23 and has an expected growth rate of -5% for the foreseeable future, if the discount rate is 7% what is the appropriate stock price today?

a.	$   9.74
b.	$ 10.25
c.	$   9.67
d.	$ 11.43

 

 

ANS:  A

g=  -0.05

D₀=  1.23

D₁=  1.17

r=  0.07

P₀=  D₁/(r-g)

P₀=  9.74

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

99. Fading Away Corporation just paid a dividend of $1.23 and has an expected growth rate of -5% for the foreseeable future, if the discount rate is 7% what is the appropriate stock price today?

a.	$ 58.86
b.	$ 47.72
c.	$ 50.35
d.	$ 47.84

 

 

ANS:  D

g=  -0.05

D₀=  8.56

D₁=  8.13

r=  0.12

P₀=D₁/(r-g)

P₀=  47.84

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

100. Beta Corp has an ROE of 15%; has just paid a dividend of $1.50; a pays 10% of its earnings out in dividends, and the appropriate discount rate is 20%; what is the current stock price?

a.	$   7.50
b.	$ 26.19
c.	$ 11.35
d.	$ 31.43

 

 

ANS:  B

g=  ROE*rr

rr=  0.9

g=  0.135

D₁=  1.703

P₀=  D₁/(r-g)

P₀=  26.19

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

101. Omega Corp has an ROE of 15%; has just paid a dividend of $1.55; a pays 0% of its earnings out in dividends,  and the appropriate discount rate is 20%; what is the current stock price?

a.	$ 7.75
b.	$ 11.88
c.	$ 35.65
d.	$ 42.78

 

 

ANS:  C

g=  ROE*rr

rr=  1.00

g=  0.150

D₁=  1.783

P₀=  D₁/(r-g)

P₀=  35.65

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

102. Zeta Corp has an ROE of 15%; has just paid a dividend of $1.55; a pays 110% of its earnings out in dividends,  and the appropriate discount rate is 20%; what is the current stock price?

a.	$   8.80
b.	$ 10.51
c.	$   8.00
d.	$   7.10

 

 

ANS:  D

g=  ROE*rr

rr=  -.10

g=  -0.015

D1=  1.576

P0=  D1/(r-g)

P0=  7.10

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

103. DDP Enterprises currently does not pay a dividend but plans to makes its first dividend payment of $1 in 3 years, if the expected growth rate is 10% per year once dividends commence, and the appropriate is discount rate is 18%, what is the current stock price today?

a.	$   8.98
b.	$   8.37
c.	$ 13.75
d.	$ 14.75

 

 

ANS:  A

g=  ROE*rr

rr=  1.00

g=  0.1000

D₃=  1.0000

D₄=  1.1000

P₃=  13.7500

P₀=  PVP₃+PVD₃

P₀=  8.9773

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

104. DDP Enterprises currently does not pay a dividend but plans to makes its first dividend payment of $1 in 3 years, if the expected growth rate is 10% per year once dividends commence, and the appropriate is discount rate is 18%, what is the current stock price today?

a.	$   8.98
b.	$   8.37
c.	$ 13.75
d.	$ 14.75

 

 

ANS:  A

g=  0.1000

D₃=  1.0000

D₄=  1.1000

P₃=  13.7500

P₀=  PVP₃+PVD₃

P₀=  8.9773

 

PTS:   1                    DIF:    M                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

105. DK Corporation currently does not pay a dividend but plans to makes its first dividend payment of $2 in 3 years, DK then plans to pay 40% of its ROE in dividends once they commence. If the appropriate is discount rate is 20% and DK expects and ROE of 22%, what is the current stock price today?

a.	$ 19.27
b.	$ 20.42
c.	$ 33.29
d.	$ 35.29

 

 

ANS:  B

g=	ROE*rr
rr=	0.60
g=	0.1320
D3=	2.0000
D4=	2.2640
P3=	33.2941
P0=	PVP3+PVD3
P0=	20.4248

 

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

106. Roxy Incorporated expects non-normal dividend growth over the next three years; that is a 20% growth rate for three years followed by growth of 10% thereafter. If the last dividend paid was $3.00 and the appropriate discount rate is 16%; what is the price of the stock today?

 

a.	$ 73.24
b.	$ 95.04
c.	$ 70.10
d.	$ 60.89

 

 

ANS:  C

D₁=  3.60

D₂=  4.32

D₃=  5.18

 

D₄=  5.70

P₃=  D₄/(r-g)

P₃=  95.04

 

PVD₁=  2.68

PVD₂=  3.21

PVD₃=  3.32

PVP₃=  60.89

 

P₀=  70.10

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

107. Emma Incorporated expects non-normal dividend growth over the next three years; that is a 0% growth rate in the first year, then 25%, and then 12% followed by growth of 8% thereafter. If the last dividend paid was $2.50 and the appropriate discount rate is 12%; what is the price of the stock today?

a.	$67.26
b.	$94.50
c.	$76.64
d.	$74.24

 

 

ANS:  D

D₁=  2.50

D₂=  3.13

D₃=  3.50

 

D₄=  3.78

P₃=  D₄/(r-g)

P₃=  94.50

 

PVD₁=  1.99

PVD₂=  2.49

PVD₃=  2.49

PVP₃=  67.26

 

P₀=  74.24

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

108. Louis Incorporated expects non-normal dividend growth over the next three years; that is a 10% growth rate in the first year, then 20%, and then 25% followed by growth of 5% thereafter.  If the last dividend paid was $0.25 and the appropriate discount rate is 12%; what is the price of the stock today?

a.	$5.18
b.	$5.46
c.	$6.19
d.	$4.40

 

 

ANS:  A

D₁=  0.28

D₂=  0.33

D₃=  0.41

 

D₄=  0.43

P₃=  D₄/(r-g)

P₃=  6.19

 

PVD₁=  0.22

PVD₂=  0.26

PVD₃=  0.29

PVP₃=  4.40

 

P₀=  5.18

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

109. Easy Points One has just paid a dividend of $2.50, has a growth rate of 11% and a current stock price of $52.65. What is the required return for the security?

a.	15.75%
b.	16.27%
c.	15.75%
d.	27.27%

 

 

ANS:  B

D₁=2.7750

Div Yield=0.0527

r=D₁/P₀  + g

 

r=0.1627

 

PTS:   1                    DIF:    E                    REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds

 

110. Harder Points One has just paid a dividend of $1.50, has a required return of 17% and a current stock price of $50.65.  What is the expected growth rate?

a.	13.63%
b.	14.04%
c.	14.44%
d.	cannot be determined

 

 

ANS:  A

g=(P₀*r –D₀)/(D₀+P₀)

 

PTS:   1                    DIF:    H                   REF:   5.2 Valuing Preferred and Common Stock

NAT:  Analysis         LOC:  understand stocks and bonds