Question 1

Value stocks are generally described as having which one of the following characteristics?

Accepted Answer

Value stocks are typically characterized by low P/E ratios, meaning that they are priced low relative to their earnings per share. This can indicate that the stock is undervalued and may be a good investment opportunity. The other choices (A, B, D, and E) are more commonly associated with growth stocks, which are focused on high growth potential and often have higher valuation ratios.

Question 2

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

Accepted Answer

The correct answer is A because the present value of the dividends is $17.29. The present value of the dividends is calculated as follows:PV = $1.75 / (1 + 0.12)^1 + $1.60 / (1 + 0.12)^2 + $1.45 / (1 + 0.12)^3 + $1.45 * (1 + 0.04) / (0.12 - 0.04) * (1 / (1 + 0.12)^3)= $1.75 / 1.12 + $1.60 / 1.2544 + $1.45 / 1.4049 + $1.45 * 1.04 / 0.08 * 1 / 1.4049= $1.5625 + $1.276 + $1.032 + $1.344= $17.29

Question 3

What is a method for valuing stock in a company that does not pay dividends?

Accepted Answer

The residual income model is a method for valuing stock in a company that does not pay dividends. This model values a company based on its ability to generate income above a required rate of return on its assets. It takes into account the company's cost of capital and the value of future cash flows. This method is useful for companies that reinvest profits instead of paying dividends.

Question 4

A firm has net income of $345,200 and total equity of $2.32 million. There are 430,000 shares of stock outstanding at a price per share of $24.50. What is the firm's price-earnings ratio?

Accepted Answer

The answer of A firm has net income of $345,200...

Question 5

Lansing Corporation reported net income of $65 million for last year. Depreciation expense totaled $15 million and capital expenditures came to $6 million. Free cash flow is expected to grow at a rate of 4.5 percent for the foreseeable future. Lansing faces a 21 percent tax rate and has a .35 debt to equity ratio with $260 million (market value)in debt outstanding. Lansing's equity beta is 1.35, the risk-free rate is currently 5 percent, and the market risk premium is estimated to be 6.5 percent. What is the current total value of Lansing's equity (in millions)? (Assume Lansing had no interest expense for the year.)

Accepted Answer

The answer of Lansing Corporation reported net income of $65...

Question 6

Georgia Nursery is a relatively young firm which just paid its first annual dividend of $.50 a share. Management projects dividend increases of 15 percent per year for five years followed by a constant growth rate of 5.0 percent annually. What is this stock worth today if the applicable discount rate is 10 percent?

Accepted Answer

To solve for the current stock price, we need to use the dividend discount model:
P = D1/(1+r) + D2/(1+r)^2 + ... + D5/(1+r)^5 + D6/(r-g) * 1/(1+r)^5
where
D1 = $0.50 (first annual dividend)
g = 5%
r = 10%
We can find the value of D6 by using the constant growth model:
D6 = D5 * (1+g)/(r-g)
D6 = $1.2824
Now we can plug in the values:
P = 0.50/(1+0.10) + 0.575/(1+0.10)^2 + 0.6613/(1+0.10)^3 + 0.7605/(1+0.10)^4 + 0.8746/(1+0.10)^5 + 1.2824/(0.10-0.05) * 1/(1+0.10)^5
P = $15.98
Therefore, the best choice is C.

Question 7

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

Accepted Answer

We can use the formula for the present value of an annuity to find the present value of the two $1.75 dividends: PV = PMT x [(1 - (1 / (1 + r)^n)) / r], where PV is the present value, PMT is the payment each period, r is the discount rate, and n is the number of periods. Plugging in the values, we get: PV = $1.75 x [(1 - (1 / (1 + 0.1)^2)) / 0.1] = $3.32.

We can then use the formula for the present value of a single sum to find the present value of the $25 liquidating dividend: PV = FV / (1 + r)^n, where FV is the future value, r is the discount rate, and n is the number of periods. Plugging in the values, we get: PV = $25 / (1 + 0.1)^3 = $18.55.

Adding the present value of the dividends ($3.32) to the present value of the liquidating dividend ($18.55) gives us the total present value: $3.32 + $18.55 = $21.87. This is the current value of the stock. Therefore, the best choice is C.

Question 8

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

Accepted Answer

The expected price of the stock one year from now can be calculated by first determining the expected earnings per share (EPS) for next year and then applying the historical P/E ratio. The expected EPS for next year is $2.10 * (1 + 5%) = $2.205. Applying the P/E ratio of 18.5, the expected stock price is $2.205 * 18.5 = $40.79.

Question 9

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

Accepted Answer

The answer of The Boston House increases its dividend each...

Question 10

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

Accepted Answer

The answer of CB Industries stock is valued at $16.80...

Question 11

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

Accepted Answer

The answer of A firm has paid annual dividends of...

Question 12

Bait 'n Tackle started paying dividends 4 years ago. The annual dividends thus far have been $.50, $.55, $.60, and $.65, respectively. What is the arithmetic average dividend growth rate?

Accepted Answer

We can use the formula for arithmetic average growth rate: 
Arithmetic average growth rate = (Ending value / Beginning value)^(1/n) - 1 
Where n is the number of years

Beginning value = $.50 
Ending value = $.65 
n = 4

Arithmetic average growth rate = ($.65 / $.50)^(1/4) - 1 
Arithmetic average growth rate = 0.0914 or 9.14%

Therefore, the answer is C- 9.14%.

Question 13

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

Accepted Answer

The answer of Canadian Adventures has earnings per share of...

Question 14

API has just paid an annual dividend of $1.39 per share and expects to increase it by 3.5 percent annually for the foreseeable future. Calculate the current value of API's common stock given a discount rate of 6 percent.

Accepted Answer

To calculate the current value of the stock, we can use the dividend discount model:
Current stock value = D / (r - g)
Where:
D = Annual dividend per share = $1.39
r = Discount rate = 6%
g = Expected annual growth rate of dividends = 3.5%
Plugging in the values:
Current stock value = 1.39 / (0.06 - 0.035) = $57.55
Therefore, the correct answer is C.

Question 15

McDucket, Inc. generates net profit of $592,000 and has a price-book ratio of 5.2. Total assets are $2,320,000 and total liabilities are $1,289,000. The company has 560,000 common stock outstanding. What is the price-to-earnings ratio?

Accepted Answer

The price-to-earnings (P/E) ratio is calculated by dividing the market price per share by the earnings per share (EPS). First, we need to find the book value of equity, which is total assets minus total liabilities: $2,320,000 - $1,289,000 = $1,031,000. The market value of equity can be found by multiplying the book value of equity by the price-book ratio: $1,031,000 * 5.2 = $5,361,200. To find EPS, divide net profit by the number of common stock outstanding: $592,000 / 560,000 = $1.057. Finally, to find the P/E ratio, divide the market value per share by EPS. The market value per share is the market value of equity divided by the number of shares outstanding: $5,361,200 / 560,000 = $9.573. So, the P/E ratio is $9.573 / $1.057 = 9.06.

Question 16

A financial performance measure based on the difference between a firm's actual earnings and required earnings is sometimes called:

Accepted Answer

The financial performance measure based on the difference between a firm's actual earnings and required earnings is called economic value added (EVA). It is used to measure how much value a company has created during a specific period of time. It is calculated as Net Operating Profit After Tax (NOPAT) - (Cost of Capital x Total Capital). It is also sometimes known as "residual income".

Quiz 6: Common Stock Valuation