Question 1

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?

Accepted Answer

The answer of Alcott's preferred stock pays a dividend of...

Question 2

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.

Accepted Answer

From an investor's perspective, preferred stock is less risky than common stock because preferred shareholders have priority over common shareholders in receiving dividends and assets in the event of liquidation. However, it's riskier than bonds because bondholders are paid before both types of stockholders. From the issuer's standpoint, bonds are considered the most risky because they come with fixed interest payments that the company is obligated to make regardless of its financial situation, increasing the risk of financial distress. Preferred stock is next because, although dividends can be suspended, there's still an expectation to pay them. Common stock is considered the least risky for the issuer since dividends are not obligatory and can be adjusted based on the company's financial health.

Question 3

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?

Accepted Answer

The answer of Connor Publishing's preferred stock pays a dividend...

Question 4

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.

Accepted Answer

Preferred stock dividends are not guaranteed in the same way bond interest payments are, and they do not typically increase annually like common stock dividends might. Preferred dividends are set at a fixed rate and can be suspended by the company in financial distress.

Question 5

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?

Accepted Answer

The correct answer is A because the current stock price is $37.05. This is calculated using the Gordon Growth Model, which is:P0 = D1 / (rs - g)where:P0 is the current stock priceD1 is the next dividend paymentrs is the required returng is the dividend growth rateIn this case, the last dividend paid 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 (rs) is 12.0%.So, the next dividend payment (D1) is:D1 = D0 * (1 + g)D1 = $1.55 * (1 + 0.015)D1 = $1.57And the current stock price (P0) is:P0 = D1 / (rs - g)P0 = $1.57 / (0.12 - 0.08)P0 = $37.05

Question 6

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?

Accepted Answer

To find the current stock price of Coppard Inc., we use the dividend discount model (DDM) for a stock with dividends growing at different rates in different periods. First, we calculate the dividends for the first three years using the 15% growth rate:- D1 = $1.25 * (1 + 0.15) = $1.4375- D2 = $1.4375 * (1 + 0.15) = $1.6531- D3 = $1.6531 * (1 + 0.15) = $1.9006Next, we calculate the stock price at the end of year 3 (P3), which is the present value of all dividends from year 4 onwards, growing at a constant rate of 6%:- P3 = D4 / (r - g) = D3 * (1 + g) / (r - g) = $1.9006 * (1 + 0.06) / (0.11 - 0.06) = $40.2126Now, we discount D1, D2, D3, and P3 back to the present value using the required return of 11%:- PV = D1 / (1 + r)^1 + D2 / (1 + r)^2 + D3 / (1 + r)^3 + P3 / (1 + r)^3- PV = $1.4375 / (1 + 0.11)^1 + $1.6531 / (1 + 0.11)^2 + $1.9006 / (1 + 0.11)^3 + $40.2126 / (1 + 0.11)^3- PV = $1.294 + $1.344 + $1.412 + $29.45- PV = $33.50Therefore, the current stock price of Coppard Inc. is $33.50.

Question 7

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? $$\begin{array} { l c c c c c c c } 
\text { Year } & 0 & 1 & 2 & 3 & 4 & 5 & 6 \
\hline \text { Growth rate } & \text { NA } & \text { NA } & \text { NA } & \text { NA } & 50.00 \% & 25.00 \% & 8.00 \% \
\text { Dividends } & \$ 0.000 & \$ 0.000 & \$ 0.000 & \$ 0.250 & \$ 0.375 & \$ 0.469 & \$ 0.506
\end{array}$$

Accepted Answer

The answer of Sawchuck Consulting has been profitable for the...

Question 8

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?

Accepted Answer

The answer of The required return for Williamson Heating's stock...

Question 9

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?

Accepted Answer

To estimate the intrinsic value of the stock, we need to use the dividend discount model: P0 = D1/(r_s - g) where P0 is the current price of the stock, D1 is the next year's dividend, r_s is the required rate of return, and g is the growth rate of dividends. We are given that D0 = $1.00, and the consensus forecast is that the dividend will grow at 10% per year for the next 3 years, then 5% per year after that. Using this information, we can calculate the expected dividends for the next 5 years: D1 = D0*(1+g1) = $1.10 D2 = D1*(1+g2) = $1.21 D3 = D2*(1+g3) = $1.33 D4 = D3*(1+g4) = $1.40 D5 = D4*(1+g4) = $1.47 To find r_s, we need to use a trial-and-error process to make the calculated price equal to the actual market price of $15.00. However, we can use Goal Seek in Excel to automate this process. Using Excel and Goal Seek, we find that the required rate of return is approximately 12.97%. Therefore, the answer is D) 12.97%.

Question 10

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?

Accepted Answer

The price of a perpetual preferred stock can be calculated using the formula: Price = Dividend / Required Return. Therefore, the price = $7.50 / 0.065 = $115.38.

Question 11

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?

Accepted Answer

First, we need to calculate the dividends for the next two years using the constant growth rate formula:

D1 = D0 x (1 + g) 
D1 = $1.75 x (1 + 0.25) = $2.19 
D2 = D1 x (1 + g) 
D2 = $2.19 x (1 + 0.25) = $2.74

Then, we can calculate the dividend at year 2 using the constant growth formula:

D2 = D1 x (1 + g) / (r - g) 
$2.74 = $2.19 x (1 + 0.25) x (1 + 0.06) / (0.12 - 0.06)

Now we can calculate the present value of the dividends and the stock price:

PV = $1.75 / (1 + 0.12) + $2.19 / (1 + 0.12)^2 + $2.74 / (1 + 0.12)^2 
PV = $4.19 
Stock price = PV + D2 / (1 + r)^2 
Stock price = $42.64

Therefore, the best estimate of the current stock price is $42.64 (option B).

Quiz 7: Corporate Valuation and Stock Valuation