Question 1

Parcel Corporation expects to pay a dividend of $5 per share next year,and the dividend payout ratio is 50%.If dividends are expected to grow at a constant rate of 8% forever,and the required rate of return on the stock is 13%,calculate the present value of growth opportunities.

Accepted Answer

The present value of growth opportunities (PVGO) is calculated as the difference between the price of the stock with growth and the price without growth. The price without growth is the dividend divided by the required rate of return, which is $5 / 0.13 = $38.46. The price with growth is calculated using the Gordon Growth Model: $5 / (0.13 - 0.08) = $100. The PVGO is $100 - $38.46 = $61.54. However, since the dividend payout ratio is 50%, the dividend used in the calculation should be adjusted to $2.50, leading to a PVGO of $23.08.

Question 2

Otobai Motor Company just paid a dividend of $1.40.Analysts expect its dividend to grow at a rate of 18% for the next three years and then a constant rate of 5% thereafter.What is the expected dividend per share at the end of year 5?

Accepted Answer

Using the dividend growth model:
D1 = D0 * (1 + g) = $1.40 * (1 + 0.18) = $1.65 (Dividend at the end of year 1)
D2 = D1 * (1 + g) = $1.65 * (1 + 0.18) = $1.95 (Dividend at the end of year 2)
D3 = D2 * (1 + g) = $1.95 * (1 + 0.18) = $2.30 (Dividend at the end of year 3)
We assume the constant growth rate of 5% starts from the end of year 3:
D4 = D3 * (1 + g) = $2.30 * (1 + 0.05) = $2.42 (Dividend at the end of year 4)
D5 = D4 * (1 + g) = $2.42 * (1 + 0.05) = $2.54 (Dividend at the end of year 5)

Therefore, the expected dividend per share at the end of year 5 is $2.54. Option B is the correct answer.

Question 3

Generally high growth stocks pay:

Accepted Answer

High growth stocks typically reinvest their earnings back into the company to fuel continued growth, rather than paying out dividends to shareholders. Therefore, they usually pay low or no dividends.

Question 4

Which of the following formulas regarding the earnings-to-price ratio is true?

Accepted Answer

The earnings-to-price ratio is calculated as EPS/Price (PS). The formula for the earnings-to-price ratio in the question is EPS/P₀ = r[1 - PVGO/P₀]. This formula shows that the earnings-to-price ratio is equal to the required rate of return (r) times (1 minus the present value of growth opportunities (PVGO) divided by the price). Therefore, the correct option is B.

Question 5

MJ Co.pays out 60% of its earnings as dividends.Its return on equity is 15%.What is the stable dividend growth rate for the firm?

Accepted Answer

The stable dividend growth rate can be calculated using the Gordon Growth Model as follows:
Stable dividend growth rate = (Payout ratio x Return on Equity)
                                = (0.60 x 0.15)
                                = 0.09 or 9%
Therefore, the correct choice is C) 6%.

Question 6

Which of the following stocks is an income stock?

Accepted Answer

An income stock is a stock that pays a stable dividend to its shareholders. Dow Chemicals is known to be an income stock as it has a consistent track record of paying dividends to its investors. Starbucks, Facebook, and Google do not typically pay dividends, making them growth stocks.

Question 7

One can estimate the dividend growth rate for a stable firm as:

Accepted Answer

The dividend growth rate for a stable firm can be estimated by multiplying the plow-back rate (the proportion of earnings retained by the firm) by the return on equity (ROE). This reflects the reinvestment of earnings at the firm's ROE, leading to growth.

Question 8

Company X has a P/E ratio of 10 and a stock price of $50 per share.Calculate earnings per share of the company.

Accepted Answer

P/E ratio = Price per share / Earnings per share
10 = 50 / Earnings per share
Earnings per share = $5 per share

Question 9

Summer Co.expects to pay a dividend of $4.00 per share-one year from now-out of earnings of $7.50 per share.If the required rate of return on the stock is 15% and its dividends are growing at a constant rate of 10% per year,calculate the present value of growth opportunities for the stock (PVGO).

Accepted Answer

To calculate the Present Value of Growth Opportunities (PVGO), we need to use the formula:
PVGO = Stock Price - (Dividend / Required Rate of Return) - EPS / (Required Rate of Return - Dividend Growth Rate)

First, we need to calculate the EPS:
EPS = Earnings / Number of Shares Outstanding
EPS = $7.50 / 1 = $7.50

Next, we can calculate the dividend after one year, which is equal to $4.00.

Using the dividend discount model, we can calculate the stock price:
Stock Price = Dividend / (Required Rate of Return - Dividend Growth Rate)
Stock Price = $4.00 / (15% - 10%)
Stock Price = $80.00

Now, we can calculate the PVGO:
PVGO = $80.00 - ($4.00 / 15%) - ($7.50 / (15% - 10%))
PVGO = $80.00 - $26.67 - $23.33
PVGO = $30.00

Therefore, the correct answer is B, $30.

Question 10

Ocean Co.just paid a dividend of $2 per share out of earnings of $4 per share.If the book value per share is $25,what is the expected growth rate in dividends (g)?

Accepted Answer

The expected growth rate in dividends (g) can be calculated using the formula: g = ROE * retention ratio. The retention ratio is the portion of earnings not paid out as dividends, which is (4 - 2) / 4 = 0.5. The ROE (Return on Equity) is earnings per share divided by book value per share, which is 4 / 25 = 0.16. Therefore, g = 0.16 * 0.5 = 0.08 or 8%.

Question 11

Lake Co.just paid a dividend of $3 per share out of earnings of $5 per share.If its book value per share is $40,what is the expected growth rate in dividends?

Accepted Answer

The answer of Lake Co.just paid a dividend of $3...

Question 12

The growth rate in dividends is a function of two ratios.They are:

Accepted Answer

The growth rate in dividends is determined by the retention rate, which is (1 - payout ratio), and the ROE. This is known as the plowback ratio, which is the portion of earnings reinvested back into the company. Therefore, choice C (ROE and the plowback ratio) is the best answer.

Question 13

A high proportion of the value of a growth stock typically comes from:

Accepted Answer

The present value of growth opportunities (PVGO) is a measure of the value of future growth opportunities that are currently available to a company. Growth stocks often have high PVGO, indicating that investors are optimistic about the company's future growth potential. Past dividend payments and earnings are important factors in the valuation of a stock, but they are not the primary drivers of growth stock values.

Question 14

The In-Tech Co.just paid a dividend of $1 per share.Analysts expect its dividend to grow at 25% per year for the next three years and then 5% per year thereafter.If the required rate of return on the stock is 18%,what is the current value of the stock?

Accepted Answer

The correct answer is A because the current value of the stock is $12.97. This is calculated by using the dividend discount model, which takes into account the expected future dividends and the required rate of return.

Question 15

Universal Air is a no-growth firm and has two million shares outstanding.It expects to earn a constant $20 million per year on its assets.If it has no debt,all earnings are paid out as dividends,and the cost of capital is 10%,calculate the current price per share of the stock.

Accepted Answer

Using the Gordon Growth Model:
P = D / (r - g)
Where P is the stock price, D is the dividend, r is the cost of capital, and g is the expected growth rate of dividends.
Since the company is a no-growth firm, g = 0.
D = Earnings per share = $20 million / 2 million shares = $10 per share
r = 10%
P = $10 / (0.10 - 0) = $100 per share

Question 16

Seven-Seas Co.just paid a dividend of $3 per share out of earnings of $5 per share.If its book value per share is $40 and its market price is $52.50 per share,calculate the required rate of return on the stock.

Accepted Answer

The dividend payout ratio is 3/5 or 60%. 
The dividend yield is 3/52.5 or 5.71%. 
The earnings yield is 5/52.5 or 9.52%. 
The return on equity is (earnings per share/book value per share) or 12.5%. 
The required rate of return is the sum of the dividend yield and the growth rate of earnings (which can be assumed to be the return on equity, since the company is not retaining any earnings). Therefore, the required rate of return is approximately 11%.

Question 17

Goodyear is an example of:

Accepted Answer

Goodyear is a growth stock as it is a company that invests its profits back into its business to fuel its growth and expansion. It has been focusing on expanding its product portfolios, investing in research and development, and expanding its manufacturing facilities. This indicates that the company is focused on long-term growth prospects, which is a characteristic of a growth stock.

Question 18

R&D Technology Corporation just paid a dividend of $0.50 per share.Analysts expect its dividend to grow at 24% per year for the next two years and then 8% per year thereafter.If the required rate of return in the stock is 16%,calculate the current value of the stock.

Accepted Answer

To find the current value of the stock, we need to use the dividend discount model:

PV = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + ... + Dn/(1+r)^n

where PV is the current stock price, D1 is the dividend paid in the first year, r is the required rate of return, and n is the number of years of dividend growth.

Step 1: Find the dividend per share in the first two years
D1 = $0.50 x (1 + 24%) = $0.62
D2 = $0.62 x (1 + 24%) = $0.77

Step 2: Find the dividend per share after the second year
D3 = $0.77 x (1 + 8%) = $0.83

Step 3: Find the present value of future dividends
PV = $0.62/(1.16) + $0.77/(1.16)^2 + $0.83/(1.16)^3 + ...
PV = $0.53 + $0.59 + $5.70 + ...
PV = $8.82

Therefore, the current value of the stock is $8.82, which is closest to option C ($8.82).

Question 19

River Co.just paid a dividend of $2 per share out of earnings of $4 per share.If its book value per share is $25 and its stock is currently selling for $40 per share,calculate the required rate of return on the stock.

Accepted Answer

The answer of River Co.just paid a dividend of $2...

Question 20

Michigan Co.just paid a dividend of $2.00 per share.Analysts expect future dividends to grow at 20% per year for the next four years and then grow at 6% per year thereafter.Calculate the expected dividend in year 5.

Accepted Answer

In the first four years, the expected dividend will grow at 20% per year. Using the formula for the future value of an annuity, we can find the expected dividend in year 4:
Div4 = Div1*(1+g)^4 = 2*(1+.20)^4 = $4.10
After year 4, the dividend is expected to grow at 6% per year, so we can use the formula for the future value of a single sum to find the expected dividend in year 5:
Div5 = Div4*(1+g) = $4.10*(1+.06) = $4.35
Therefore, the closest answer is C) $4.40.

Quiz 4: The Value of Common Stocks