Question 1

Rancid Fruit Co.just paid a dividend of $1.00 and expects to increase it at a rate of 5% annually.All else equal,under which of the following conditions would its stock price fall in one year?

Accepted Answer

Falling short of expectations sends a negative signal to shareholders which usually causes them to sell the stock, lowering its price.

Question 2

What is the maximum price Erica should pay for Rangoon Corp.common stock if her required return is 5% and she expects to sell the stock in one year for $50 per share,immediately after she receives a $.50 per share dividend? (Round to the nearest tenth.)

Accepted Answer

Step 1 - Calculate the growth rate using the Gordon Model. 11ea7fdb_fbf7_d59b_a768_23a693c8ea55_TB2902_11 = 11ea7fdb_fbf7_d59c_a768_7f44ab1b5610_TB2902_11 50 = 11ea7fdb_fbf7_d59d_a768_ef70c2cae9a0_TB2902_11 2.5 - 50g = .50
2 = 50g
g = 4%
Step 2 - Use the growth rate to discount the future price of $50 back to today.
PV = 11ea7fdb_fbf7_fcae_a768_0f65b636c8d4_TB2902_11 = $48.08 or $48.10

Question 3

Berg Inc.has just paid a dividend of $2.Its stock is now selling for $48 per share.The firm is half as risky as the market.The expected return on the market is 14%,and the yield on U.S.Treasury bonds is 11%.If the market is in equilibrium,what rate of growth is expected?

Accepted Answer

Step 1 - Calculate the required rate of return using CAPM. k_e = k_F + β(k_M - k_F ) k_e= .11 + .5(.14 - .11) k_e = 12.5% Step 2 - Calculate the growth rate by using the Gordon Model. 11ea7fdb_fbf7_fcaf_a768_3fa9b0abeec9_TB2902_11 = 11ea7fdb_fbf7_fcb0_a768_2f55c572064f_TB2902_11 48 = 11ea7fdb_fbf7_fcb1_a768_33d13b4c83f5_TB2902_11 6 - 48g = 2 × (1 + g) 6 - 48g = 2 + 2g 4 = 50g g = 8%

Question 4

If the last dividend on Markowitz Trucking stock was $2 per share and if dividends are expected to grow 10% annually,what is the share price if the required return is 12%?

Accepted Answer

Step 1 - Calculate the next dividend payment.
2 × (1.10) = $2.20
Step 2 - Plug the next dividend payment into the Gordon Model. 11ea7fdb_fbf7_ae87_a768_617298048b44_TB2902_11 = 11ea7fdb_fbf7_ae88_a768_e71e602763e7_TB2902_11 11ea7fdb_fbf7_ae89_a768_cbb3ed79f78f_TB2902_11 = 11ea7fdb_fbf7_d59a_a768_dbe0bb5f13f8_TB2902_11 = $110

Question 5

A share of common stock has just paid a dividend of $2.If the expected long-run growth rate for this stock is 15%,and if investors require a 19% rate of return,what is the price of the stock?

Accepted Answer

Step 1 - Calculate the next dividend payment.
2 × (1.15) = $2.30
Step 2 - Calculate the price of the stock using the Gordon Model. 11ea7fdb_fbf8_4ad6_a768_f7612137e172_TB2902_11 = 11ea7fdb_fbf8_4ad7_a768_a7bbddd92703_TB2902_11 11ea7fdb_fbf8_4ad8_a768_9de996168a9e_TB2902_11 = 11ea7fdb_fbf8_71e9_a768_273df0aa0076_TB2902_11 = 57.50

Question 6

If the price of River Bank stock is $35,next year's dividend is expected to be $2.50,and the required return is 15%,what is the expected dividend growth rate?

Accepted Answer

11ea7fdb_fbf9_354d_a768_8fdde47425af_TB2902_11 = 11ea7fdb_fbf9_354e_a768_2125f17c2dc0_TB2902_11 35 = 11ea7fdb_fbf9_354f_a768_3b349fb9286c_TB2902_11 5.25 - 35g = 2.50
2.75 = 35g
g = .0785 or 7.9%

Question 7

If the price of Iguana Handbags Inc.stock is $43,its required return is 20%,and the last dividend was $3,what is its dividend growth rate? (Round to the nearest tenth.)

Accepted Answer

11ea7fdb_fbfa_1fc4_a768_7d066c634558_TB2902_11 = 11ea7fdb_fbfa_46d5_a768_a75851571f6b_TB2902_11 43 = 11ea7fdb_fbfa_46d6_a768_cde3f2a7646d_TB2902_11 8.6 - 43g = 3 × (1 + g)
8.6 - 43g = 3 + 3g
5.6 = 46g
g = .1217 or 12.2%

Question 8

A stock just paid a dividend of $1.15,has a required rate of return of 10%,and a constant dividend growth rate of 3%.What price should this stock be selling for?

Accepted Answer

Step 1 - Calculate the next dividend payment.
1.15 × (1.03) = $1.1845
Step 2 - Calculate the price of the stock using the Gordon Model. 11ea7fdb_fbf9_0e39_a768_9be28eb9dec5_TB2902_11 = 11ea7fdb_fbf9_0e3a_a768_7d18e722a855_TB2902_11 11ea7fdb_fbf9_0e3b_a768_575bb767af00_TB2902_11 = 11ea7fdb_fbf9_354c_a768_99878352ee32_TB2902_11 = $16.92

Question 9

What is the required return from Truman Planned Community stock if its beta is 1.1,the return on the market portfolio is 12%,the risk free rate is 3%,next year's dividend will be $1.25 per share and dividends are expected to grow 5% per year?

Accepted Answer

k_e = k_F + β(k_M - k_F ) k_e= .03 + 1.1(.12 - .03) k_e = 12.9%

Question 10

Fuller Corp.stock just paid a dividend of $3.12.Fuller's dividend growth rate has averaged 3% historically,and Fuller stock currently sells for $25.What is the required return on equity?

Accepted Answer

Step 1 - Calculate the next dividend payment.
3.12 × (1.03) = $3.2136
Step 2 - Use the Gordon Model to solve for the required return. 11ea7fdb_fbf9_5c60_a768_c35794e9c328_TB2902_11 = 11ea7fdb_fbf9_5c61_a768_edad74277f98_TB2902_11 25 = 11ea7fdb_fbf9_5c62_a768_677c86206563_TB2902_11 25k - .75 = 3.2136
25k = 3.9636
k = .158 or 16%

Question 11

A high-yield stock is one:

Accepted Answer

A high-yield stock has a high dividend growth rate.

Question 12

One year ago Indigo Company paid a $4 dividend,and during the current year it has experienced a 10% growth rate.The company just paid a dividend of $4.40,i.e.,D(o)= 4.40.Due to a new,advanced production technique,Indigo expects to achieve a dramatic increase in its short-term growth rate,to 25% annually for the next 3 years.After this time,growth is expected to return to the long-run constant rate of 10%.If investors require a 15% rate of return,at what price should the stock of Indigo Company be selling today? (Round to the nearest whole dollar.)

Accepted Answer

Step 1 - Calculate the present value of the high-growth cash flows.
PV = 11ea7fdb_fbf8_71ea_a768_bb864801e904_TB2902_11 = $4.78
PV = 11ea7fdb_fbf8_71eb_a768_193cc3ee9eb2_TB2902_11 = $5.20
PV = 11ea7fdb_fbf8_98fc_a768_97083d67ab92_TB2902_11 = $5.65
Step 2 - Add these cash flows together.
4.78 + 5.20 + 5.65 = $15.63
Step 3 - Calculate the constant-growth cash flows and discount them back to today. 11ea7fdb_fbf8_98fd_a768_4b213fe7689b_TB2902_11 = 11ea7fdb_fbf8_98fe_a768_5b50844fbb0e_TB2902_11 11ea7fdb_fbf8_98ff_a768_f16a3181e198_TB2902_11 = 11ea7fdb_fbf8_9900_a768_71c746570b37_TB2902_11 = $189.06
PV = 11ea7fdb_fbf8_9901_a768_d5de9777a91f_TB2902_11 = $124.31
Step 4 - Add the two discounted totals together to get the stock price today.124.31 + 15.63 = $139.94 or $140

Question 13

The next dividend on Sciorra stock is expected to be $3.10 per share.Dividends are expected to grow at a constant rate of 5% indefinitely.What should the current share price be if Sciorra investors require a return of 15%?

Accepted Answer

11ea7fdb_fbf9_d19c_a768_35f5f0febefd_TB2902_11 = 11ea7fdb_fbf9_d19d_a768_e5a85b95366e_TB2902_11 11ea7fdb_fbf9_f8ae_a768_973eb14bf619_TB2902_11 = 11ea7fdb_fbf9_f8af_a768_eb1f16951459_TB2902_11 = $31.00

Question 14

If the current price of Thaler-Made Furniture is $25 per share and next year's dividend is expected to be $1.75 per share,what is the required return if dividends are expected to grow 5% per year?

Accepted Answer

11ea7fdb_fbf8_c012_a768_0faff7cef39a_TB2902_11 = 11ea7fdb_fbf8_c013_a768_cb04383e22be_TB2902_11 25 = 11ea7fdb_fbf8_c014_a768_afc2acda35f4_TB2902_11 25k - 1.25 = 1.75
25k = 3
k = 12%

Question 15

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

Accepted Answer

Step 1 - Calculate the next dividend payment.
4 × (1.10) = $4.40
Step 2 - Calculate the price of the stock using the Gordon Model. 11ea7fdb_fbf8_23c2_a768_8dfce62ddd3e_TB2902_11 = 11ea7fdb_fbf8_23c3_a768_359c3cbd0082_TB2902_11 11ea7fdb_fbf8_23c4_a768_63fe41526693_TB2902_11 = 11ea7fdb_fbf8_4ad5_a768_77f8c442393f_TB2902_11 = 44

Question 16

The last dividend paid on Minsky Corp.stock was $3 per share.If Minsky investors require a 10% return,what should the share price be if the dividend payments are not expected to change?

Accepted Answer

11ea7fdb_fbf8_e725_a768_a3d1110407f6_TB2902_11 = 11ea7fdb_fbf8_e726_a768_9f2b1a10d063_TB2902_11 11ea7fdb_fbf8_e727_a768_1bef199b8372_TB2902_00 = 11ea7fdb_fbf8_e728_a768_07b529cbdf0b_TB2902_00 = 30

Question 17

Motor Homes Inc.(MHI)is presently in a stage of abnormally high growth because of a surge in the demand for motor homes.The company expects earnings and dividends to grow at a rate of 20% for the next 4 years,after which time there will be no growth (g=0)in earnings and dividends.The company's last dividend was $1.50.MHI has a beta of 1.6,the return on the market is currently 12.75%,and the risk-free rate is 4%.What should be the current price per share of common stock?

Accepted Answer

Step 1 - Calculate the required rate of return using CAPM. k_e = k_F + β(k_M - k_F ) k_e= .04 + 1.6(.1275 - .04) k_e = 18% Step 2 - Calculate the present value of the high-growth cash flows. PV = 11ea7fdb_fbf9_8373_a768_e9f4900a4b89_TB2902_11 = $1.53 PV = 11ea7fdb_fbf9_8374_a768_d5b0903b29c4_TB2902_11 = $1.55 PV = 11ea7fdb_fbf9_8375_a768_0f3227f6c6f9_TB2902_11 = $1.58 PV = 11ea7fdb_fbf9_aa86_a768_d76388e4de49_TB2902_11 = $1.60 Step 3 - Add these cash flows together. 1.53 + 1.55 + 1.58 + 1.60 = $6.26 Step 4 - Calculate the zero-growth cash flows and discount them back to today. 11ea7fdb_fbf9_aa87_a768_1111e0955543_TB2902_11 = 11ea7fdb_fbf9_aa88_a768_b54e3f5e77e7_TB2902_11 11ea7fdb_fbf9_aa89_a768_1787a9822f5e_TB2902_11 = 11ea7fdb_fbf9_aa8a_a768_d917273d66e9_TB2902_11 = $17.28 PV = 11ea7fdb_fbf9_aa8b_a768_5fd94a8fda33_TB2902_11 = $8.91 Step 5 - Add the two discounted totals together to get the stock price today. 6.26 + 8.91 = $15.17

Question 18

The basic assumption of the Gordon growth model is that:

Accepted Answer

The Gordon Model assumes dividends will grow at a constant rate forever.

Question 19

An increase in a firm's market risk should be reflected in what part(s)of the Gordon growth model?

Accepted Answer

An increase in a firm's market risk will also increase the investor's required return of the stock.

Question 20

If the last dividend paid by Chemical Brothers Inc.was $1.25 and analysts expect these payments to increase 4% per year,what will the stock price be next year if the required return is 15%?

Accepted Answer

Step 1 - Calculate the next dividend payment.
1.25 × (1.04) = $1.30
Step 2 - Plug the next dividend payment into the Gordon Model. 11ea7fdb_fbf9_f8b0_a768_e35cadc533d2_TB2902_11 = 11ea7fdb_fbf9_f8b1_a768_cb883e245e16_TB2902_11 11ea7fdb_fbf9_f8b2_a768_ab5fb1c86bc9_TB2902_11 = 11ea7fdb_fbfa_1fc3_a768_89727f054ed8_TB2902_11 = 11.82
Step 3 - Calculate the price of the stock for next year.
11.82 × (1.04) = $12.29

Quiz 8: Stock Valuation and Market Efficiency