Question 1

Firm A is high risk and Firm B is low risk.Everything else equal,which firm would you expect to have a higher P/E ratio?

Accepted Answer

The answer of Firm A is high risk and Firm...

Question 2

Suppose that in 2009 the expected dividends of the stocks in a broad market index equaled $240 million when the discount rate was 8% and the expected growth rate of the dividends equaled 6%.Using the constant growth formula for valuation,if interest rates increase to 9% the value of the market will change by _____.

Accepted Answer

The answer of Suppose that in 2009 the expected dividends...

Question 3

Flanders,Inc.has expected earnings of $4 per share for next year.The firm's ROE is 8% and its earnings retention ratio is 40%.If the firm's market capitalization rate is 15%,what is the present value of its growth opportunities?

Accepted Answer

Value with no growth = $4/0.15 = $26.67
Growth rate = 0.4 × 8% = 3.2%
Value with growth = $4 × (1 − 0.4)/(0.15 − 0.032) = $20.34
PVGO = $20.34 − 26.67 = −$6.33

Question 4

A firm is planning on paying its first dividend of $2 after two years.Then dividends are expected to grow at 6% per year indefinitely.The stock's required return is 14%.What is the intrinsic value of a share today?

Accepted Answer

Using the Gordon Growth Model, we can calculate the intrinsic value of the share today:

V0 = D1 / (r - g)

where
D1 = expected dividend in one year = D0 × (1 + g) = $2 × (1 + 6%) = $2.12
D0 = current dividend = $0 (none paid yet)
r = required return = 14%
g = expected growth rate = 6%

V0 = $2.12 / (0.14 - 0.06) = $19.24

Therefore, the intrinsic value of the share today is $19.24. The correct answer is C.

Question 5

Weyerhaeuser Incorporated has a balance sheet which lists $70 million in assets,$45 million in liabilities and $25 million in common shareholders' equity.It has 1,000,000 common shares outstanding.The replacement cost of its assets is $85 million.Its share price in the market is $49.Its book value per share is _________.

Accepted Answer

Book value per share is calculated as total common shareholders' equity divided by the number of common shares outstanding. In this case, the book value per share is $25 ($25 million common shareholders' equity / 1,000,000 common shares outstanding).

Question 6

The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%.Its expected ROE is 12% and its expected EPS is $5.00.If the firm's plow-back ratio is 60%,its P/E ratio will be _________.

Accepted Answer

The answer of The market capitalization rate on the stock...

Question 7

Rose Hill Trading Company is expected to have EPS in the upcoming year of $6.00.The expected ROE is 18.0%.An appropriate required return on the stock is 14%.If the firm has a plowback ratio of 70%,its intrinsic value should be _________.

Accepted Answer

The answer of Rose Hill Trading Company is expected to...

Question 8

Rose Hill Trading Company is expected to have EPS in the upcoming year of $8.00.The expected ROE is 18.0%.An appropriate required return on the stock is 14%.If the firm has a plowback ratio of 70%,its dividend in the upcoming year should be _________.

Accepted Answer

The answer of Rose Hill Trading Company is expected to...

Question 9

Annie's Donut Shops,Inc.has expected earnings of $3.00 per share for next year.The firm's ROE is 18% and its earnings retention ratio is 60%.If the firm's market capitalization rate is 12%,what is the value of the firm excluding any growth opportunities?

Accepted Answer

The value of the firm excluding growth opportunities (also known as the no-growth value) can be calculated using the formula: Value = Earnings per share / Market capitalization rate. Here, it is $3.00 / 0.12 = $25.00.

Question 10

Grott and Perrin,Inc.has expected earnings of $3 per share for next year.The firm's ROE is 20% and its earnings retention ratio is 70%.If the firm's market capitalization rate is 15%,what is the present value of its growth opportunities?

Accepted Answer

Value with no growth = $3/0.15 = $20
Growth rate = 0.7 × 20% = 14%
Value with growth = $3 × (1 − 0.7)/(0.15 − 0.14) = $90
PVGO = $90 − 20 = $70

Question 11

The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%.Its expected ROE is 12% and its expected EPS is $5.00.If the firm's plow-back ratio is 50%,its P/E ratio will be _________.

Accepted Answer

The answer of The market capitalization rate on the stock...

Question 12

A preferred share of Coquihalla Corporation will pay a dividend of $8.00 in the upcoming year,and every year thereafter,i.e.,dividends are not expected to grow.You require a return of 7% on this stock.Using the constant growth DDM to calculate the intrinsic value,a preferred share of Coquihalla Corporation is worth _________.

Accepted Answer

According to the constant growth DDM formula, the intrinsic value of a stock is equal to the expected dividend divided by the difference between the required return and the expected dividend growth rate. In this case, the expected dividend is $8.00, the required return is 7%, and the expected dividend growth rate is 0% since dividends are not expected to grow. 
Therefore, the intrinsic value of the preferred share can be calculated as:

Intrinsic value = $8.00 / (0.07 - 0%) = $114.29

Hence, the correct choice is D) $114.29.

Question 13

Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year.Dividends are expected to grow at 8% per year.The riskfree rate of return is 4% and the expected return on the market portfolio is 14%.Investors use the CAPM to compute the market capitalization rate,and the constant growth DDM to determine the value of the stock.The stock's current price is $84.00.Using the constant growth DDM,the market capitalization rate is _________.

Accepted Answer

To use the constant growth DDM formula, we need to calculate the required rate of return or market capitalization rate (R) first. 
R = Rf + β(Rm - Rf) 
where Rf = risk-free rate = 4%, Rm = expected return on the market portfolio = 14%, and β = beta of the stock, which is not given. 
Since we do not have beta, we cannot compute R using the CAPM. However, we can use the dividend growth model to find the implied market capitalization rate. 
Using the formula: 
P0 = D1 / (R - g) 
where P0 = current stock price = $84.00, D1 = next year's dividend = $3.36, and g = expected growth rate of dividends = 8%. 
Plugging in the values: 
$84.00 = $3.36 / (R - 8%) 
Solving for R, we get: 
R = 12% 
Therefore, the market capitalization rate implied by the constant growth DDM is 12%.

Question 14

You are considering acquiring a common share of Sahali Shopping Center Corporation that you would like to hold for one year.You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year.The maximum price you would pay for a share today is __________ if you wanted to earn a 12% return.

Accepted Answer

To calculate the maximum price we can pay for the share today, we need to use the formula for the present value of a stock:
PV = D1/(1+r) + P/(1+r)
where:
PV = present value
D1 = expected dividend at the end of the year
r = desired rate of return
P = expected selling price of the share

Plugging in the values we have:
PV = 1.25/(1+0.12) + 35/(1+0.12) = 1.1161 + 31.2528 = 32.37

Therefore, the maximum price we would pay for the share today to earn a 12% return is $32.37. Choice B is the correct answer.

Question 15

Eagle Brand Arrowheads has expected earnings of $1.25 per share and a market capitalization rate of 12%.Earnings are expected to grow at 5% per year indefinitely.The firm has a 40% plowback ratio.By how much does the firm's ROE exceed the market capitalization rate?

Accepted Answer

The answer of Eagle Brand Arrowheads has expected earnings of...

Question 16

Brevik Builders has an expected ROE of 25%.Its dividend growth rate will be __________ if it follows a policy of paying 30% of earning in the form of dividends.

Accepted Answer

The dividend growth rate (g) can be calculated using the formula: g = ROE * (1 - payout ratio). Here, the payout ratio is 30%, so the retention ratio is 70% (1 - 0.30). Therefore, g = 25% * 70% = 17.5%.

Question 17

Gagliardi Way Corporation has an expected ROE of 15%.If it pays out 30% of it earnings as dividends,its dividend growth rate will be _____.

Accepted Answer

The dividend growth rate can be calculated using the formula: 
Dividend growth rate = (1 - Payout ratio) x Return on Equity 
= (1 - 0.30) x 0.15 
= 0.105 or 10.5% 
Therefore, the correct answer is B.

Question 18

Each of two stocks,A and B,are expected to pay a dividend of $7 in the upcoming year.The expected growth rate of dividends is 6% for both stocks.You require a return of 10% on stock A and a return of 12% on stock B. Using the constant growth DDM, the intrinsic value of stock A _________.

Accepted Answer

The intrinsic value of a stock using the constant growth DDM formula is:

Intrinsic value = Dividend / (Required rate of return - Growth rate)

For stock A:
Intrinsic value = 7 / (0.1 - 0.06) = $175

For stock B:
Intrinsic value = 7 / (0.12 - 0.06) = $58.33

Since the intrinsic value of stock A is higher than that of stock B, the answer is A, i.e. the intrinsic value of stock A will be higher than the intrinsic value of stock B.

Question 19

Ace Ventura,Inc.has expected earnings of $5 per share for next year.The firm's ROE is 15% and its earnings retention ratio is 40%.If the firm's market capitalization rate is 10%,what is the present value of its growth opportunities?

Accepted Answer

Value with no growth = $5/0.10 = $50
Growth rate = 0.4 × 15% = 6%
Value with growth = $5 × (1 − 0.4)/(0.10 − 0.06) = $75
PVGO = $75 − 50 = $25

Question 20

You wish to earn a return of 11% on each of two stocks,A and B. Stock A is expected to pay a dividend of $3 in the upcoming year while stock B is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends for both stocks is 4%. Using the constant growth DDM, the intrinsic value of stock A _________.

Accepted Answer

Using the constant growth DDM formula, we can calculate the intrinsic value of both stocks:
Intrinsic Value = Dividend / (Required Rate of Return - Dividend Growth Rate)

For Stock A:
Intrinsic Value = 3 / (0.11 - 0.04) = $50

For Stock B:
Intrinsic Value = 2 / (0.11 - 0.04) = $33.33

Therefore, the intrinsic value of Stock A is higher than the intrinsic value of Stock B.

Quiz 13: Equity Valuation