Question 1

If the expected rate of return on a stock exceeds the required rate, it means that _____

Accepted Answer

If the expected rate of return on a stock exceeds the required rate, it means that the stock is likely undervalued and represents a good buying opportunity as its potential return exceeds its cost of acquisition.

Question 2

When using the Dividend Discount Model, assuming that growth (g) will remain constant, under which of the following circumstances will the dividend yield be equal to the required return on a common stock (rs)?

Accepted Answer

If growth (g) is equal to 0, the dividend will not be increasing, and the price of the stock will not appreciate. Therefore, the only way investors can receive a return on their investment is through the dividend yield (which is the percentage of the current stock price that is paid out to investors in the form of dividends). In this scenario, the dividend yield will be equal to the required return on the common stock (rs).

Question 3

Nahanni Treasures Corporation is planning a new common stock issue of five million shares to fund a new project. The increase in shares will bring the number of shares outstanding to 25 million. Nahanni's long-term growth rate is 6 percent, and its current required rate of return is 12.6 percent. The firm just paid a $1.00 dividend and the stock sells for $16.06 in the market. On the announcement of the new equity issue, the firm's stock price dropped. Nahanni estimates that the company's growth rate will increase to 6.5 percent with the new project, but since the project is riskier than average, the firm's cost of capital will increase to 13.5 percent. Using the DDM constant growth model, what is the change in the equilibrium stock price?

Accepted Answer

The answer of Nahanni Treasures Corporation is planning a new...

Question 4

The constant growth Dividend Discount Model (DDM) may be written as _____.

Accepted Answer

The constant growth Dividend Discount Model (DDM) is represented by D1/(rs - g) where D1 is the expected dividend for the next period, rs is the required rate of return, and g is the constant growth rate. This formula calculates the present value of a stock based on its future dividends. Thus, choice D is the best option as it follows this formula.

Question 5

The P/E ratio gives an indication of _____.

Accepted Answer

The answer of The P/E ratio gives an indication of...

Question 6

A share of a preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the simple annual rate of return?

Accepted Answer

To calculate the simple annual rate of return, we need to find the annual dividend payment and divide it by the current price of the stock. Since the share of preferred stock pays a quarterly dividend of $2.50, the annual dividend payment can be calculated as follows:
Annual dividend payment = 4 x $2.50 = $10
Now, we can calculate the simple annual rate of return as follows:
Simple annual rate of return = (Annual dividend payment / Current price of the stock) x 100%
= ($10 / $50) x 100% = 20%
Therefore, the best choice is C, as it provides the correct simple annual rate of return for the given preferred stock.

Question 7

A share of perpetual preferred stock pays an annual dividend of $6 per share. If investors require a 12 percent rate of return, what should be the price of this preferred stock?

Accepted Answer

The price of a perpetual preferred stock can be calculated using the formula: Price = Dividend / Required Rate of Return. Plugging in the given values: Price = $6 / 0.12 = $50.00.

Question 8

Certificates representing ownership in stocks of foreign companies, which are held in a trust bank located in the country the stock is traded are called _____.

Accepted Answer

Certificates representing ownership in stocks of foreign companies held in a trust bank located in the country the stock is traded are called American depository receipts (ADRs). ADRs are issued by U.S. banks that purchase shares of foreign companies and deposit them in a U.S. bank in the form of ADR certificates. These certificates are then traded on U.S. stock exchanges like regular stocks.

Question 9

A share of a preferred stock pays a dividend of $0.50 each quarter. If you are willing to pay $20.00 for this preferred stock, what is your simple (not effective) annual rate of return?

Accepted Answer

The answer of A share of a preferred stock pays...

Question 10

Alpha's preferred stock currently has a market price equal to $80 per share. If the dividend paid on this stock is $6 per share, what is the required rate of return investors are demanding from Alpha's preferred stock?

Accepted Answer

The required rate of return is calculated by dividing the dividend by the market price: $6 / $80 = 0.075 or 7.5%.

Question 11

What is the risk of investing money in American depository receipts (ADRs)?

Accepted Answer

The risk of investing in American depository receipts (ADRs) is primarily associated with the corporations in which the investments are made. ADRs represent ownership in a foreign corporation, so the risks associated with that corporation, such as political instability in the country where it is based or poor financial performance, can impact the value of the ADR.

Question 12

Which of the following is considered as a Euro stock?

Accepted Answer

A Euro stock refers to a stock of a company that is listed and traded on a European stock exchange. Therefore, a German company (from Europe) selling its stock in Japan qualifies as a Euro stock. Choices A, B, C, and E do not fit this definition.

Question 13

On January 1, 2016, the price of a stock is 42.50, whereas on December 31, 2016, the price of the stock is 48.78. Determine the capital gain yield of the stock.

Accepted Answer

The answer of On January 1, 2016, the price of...

Question 14

A share of common stock has a current price of $82.50 and is expected to grow at a constant rate of 10 percent. If you require a 14 percent rate of return, what is the current dividend on this stock?

Accepted Answer

The answer of A share of common stock has a...

Question 15

In international markets, excluding stocks sold in the United States, what is a stock that is traded in a country other than the issuing company's home country called?

Accepted Answer

A stock that is traded in a country other than the issuing company's home country is called a Euro stock. A is incorrect because American Depository Receipts are stocks of foreign companies that are traded in the United States. B is incorrect because Yankee stock is a bond denominated in U.S. dollars that is issued by a foreign government or corporation and sold in the United States. D is incorrect because Class A stock refers to a type of common stock that typically has more voting rights than Class B or Class C shares. E is incorrect because Preferred stock is a type of stock that typically pays a fixed dividend and has priority over common stock in terms of dividends and asset distribution in the event of liquidation.

Question 16

If a German company sells its stock in the United States, it is termed as _____.

Accepted Answer

When a German company sells its stock in the United States, it is referred to as Yankee stock.

Question 17

The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?

Accepted Answer

The answer of The last dividend on Spirex Corporation's common...

Question 18

What is the formula to calculate P/E ratio?

Accepted Answer

The formula for P/E ratio is (Market price per share ÷ Earnings per share), which is represented by option D.

Question 19

A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock?

Accepted Answer

To determine the value of the stock, we use the dividend discount model for a stock with non-constant growth initially, followed by constant growth. First, we find the present value of the dividends during the non-constant growth period:- Year 1 Dividend: $2.00 / (1 + 0.14)^1 = $1.75- Year 2 Dividend: $1.50 / (1 + 0.14)^2 = $1.15- Year 3 Dividend: $2.50 / (1 + 0.14)^3 = $1.73- Year 4 Dividend: $3.50 / (1 + 0.14)^4 = $2.15Next, we calculate the present value of the stock at the end of Year 4, just before it begins to grow at a constant rate. This is done using the Gordon Growth Model (also known as the Dividend Growth Model for a perpetuity with growth):$$ P_4 = \frac{D_5}{r - g} = \frac{3.50 \times (1 + 0.08)}{0.14 - 0.08} = \frac{3.78}{0.06} = \$63.00 $$Then, we discount this value back to the present:$$ PV = \frac{\$63.00}{(1 + 0.14)^4} = \$36.12 $$Finally, we sum up the present values of the dividends and the discounted value of the stock:$$ Total Value = \$1.75 + \$1.15 + \$1.73 + \$2.15 + \$36.12 = \$43.90 $$The calculation closely matches option E) $43.97, considering slight differences could be due to rounding at different steps.

Question 20

You are trying to determine the appropriate price to pay for a share of common stock. If you purchase this stock, you plan to hold it for 1 year. At the end of the year you expect to receive a dividend of $5.50 and to sell the stock for $154. The appropriate rate of return for this stock is 16 percent. What should the current price of this stock be?

Accepted Answer

The current price of the stock can be calculated using the dividend discount model for a one-year holding period, which is given by the formula: $$P_0 = \frac{D_1 + P_1}{(1 + r)}$$ where $P_0$ is the current price of the stock, $D_1$ is the dividend received at the end of the year, $P_1$ is the price of the stock at the end of the year, and $r$ is the required rate of return. Plugging in the given values: $$P_0 = \frac{5.50 + 154}{(1 + 0.16)} = \frac{159.50}{1.16} = 137.50$$ Therefore, the current price of the stock should be $137.50.

Quiz 7: Stocks Equity Characteristics and Valuation