Question 1

The constant-growth dividend valuation model is best suited for use with

Accepted Answer

The constant-growth dividend valuation model assumes that the stock being valued is a mature, stable company that pays a steady dividend and is growing at a constant rate. Therefore, it is best suited for use with the stocks of mature, dividend-paying companies.

Question 2

Walpurg, Inc.paid $1.30 as an annual dividend per share last year.The company is expected to increase their annual dividends by 6% each year.How much should you pay to purchase one share of this stock if you require a 9% rate of return on this investment?

Accepted Answer

The value of a stock with growing dividends can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a growing dividend), which is P = D1 / (r - g), where P is the price of the stock, D1 is the dividend next year, r is the required rate of return, and g is the growth rate of the dividend. In this case, D1 = $1.30 * (1 + 6%) = $1.378, r = 9% or 0.09, and g = 6% or 0.06. Plugging these values into the formula gives P = $1.378 / (0.09 - 0.06) = $45.93.

Question 3

What is the required rate of return on a common stock that is expected to pay a $0.75 annual dividend next year if dividends are expected to grow at 2 percent annually and the current stock price is $8.59?

Accepted Answer

The required rate of return can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity with growth), which is given by the formula: Required Rate of Return = (D1 / P0) + g, where D1 is the dividend next year, P0 is the current stock price, and g is the growth rate. Plugging in the values: Required Rate of Return = ($0.75 / $8.59) + 0.02 = 0.0873 or 8.73%. However, due to a calculation mistake in interpreting the options, the correct mathematical result of 8.73% was intended, but the selection of option C (10.73%) was incorrect. The correct choice should have been A (8.73%).

Question 4

The Hopkinton Company just paid $2.25 as its annual dividend.The dividends have been increasing at a rate of 5% annually and this trend is expected to continue.The stock is currently selling for $63.60 a share.What is the rate of return on this stock?

Accepted Answer

To calculate the rate of return, we need to use the formula:
Rate of Return = (Dividend Payment/Stock Price) + Dividend Growth Rate

Dividend Payment = $2.25
Stock Price = $63.60
Dividend Growth Rate = 5%

Rate of Return = ($2.25/$63.60) + 5% = 8.7%

Therefore, the rate of return on this stock is 8.7%, which is option C.

Question 5

Lindor Inc.'s $100 par value preferred stock pays a dividend fixed at 8% of par.To earn 12% on an investment in this stock, you need to purchase the shares at a per share price of

Accepted Answer

To earn a 12% return on a preferred stock with a fixed 8% dividend, you must rely on capital appreciation to provide the additional 4% return. This means that you need to purchase the stock at a discount in order to achieve a higher yield.

To calculate the per share price that will provide a 12% return, we can use the following formula:

Dividend Yield + Capital Appreciation Yield = Total Return

0.08 + ((Par Value - Purchase Price) / Purchase Price) = 0.12

Solving for Purchase Price, we get:

Purchase Price = Par Value / (1 + Capital Appreciation Yield)

Purchase Price = $100 / (1 + 0.04) = $96.15

Since the question is asking for the per share price, we need to divide the purchase price by the par value:

$96.15 / $100 = 0.9615 or 96.15%

Therefore, the per share price that will provide a 12% return is $96.15, which is closest to answer choice B: $66.67 (since each share has a par value of $100, we need to purchase the shares at a per share price of $66.67 to achieve a 12% return). The other answer choices are either too high or too low.

Question 6

The intrinsic value of a zero-growth stock can be found simply by dividing the dividend by the required rate of return.

Accepted Answer

This formula is known as the dividend discount model and it assumes that the stock's value is based solely on the present value of its future dividends. However, this formula may not be accurate for stocks that experience growth or have other factors influencing their value.

Question 7

The dividend valuation model (DVM)cannot accommodate which of the following assumptions?

Accepted Answer

The dividend valuation model (DVM) assumes that dividends grow at a rate that is less than the required rate of return. If dividends were to grow at a rate greater than the required rate of return, the model would produce unrealistic and infinite values, making it inapplicable.

Question 8

Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend of $3.00 per share.This dividend has remained constant over the past few years and is expected to remain constant for some time to come.If you want to earn 11% on an investment in the common stock of Michelak's, how much should you pay to purchase each share of stock?

Accepted Answer

The price of the stock can be calculated using the dividend discount model for a perpetuity: Price = Dividend / Required Rate of Return. Here, Price = $3.00 / 0.11 = $27.27.

Question 9

The required rate of return necessary for the dividend valuation model can be estimated using

Accepted Answer

The required rate of return for the dividend valuation model can be estimated using any or all of the methods mentioned: the Capital Asset Pricing Model (CAPM), comparisons to similar risk stocks, or a subjective assessment over less risky investments.

Question 10

Newton, Inc.just paid an annual dividend of $0.95.Their dividends are expected to increase by 4% annually.Newton Company stock is selling for $11.54 a share.What is the required rate of return on this stock implied by the dividend-growth model?

Accepted Answer

Using the dividend growth model, we can calculate the implied required rate of return as follows:

Required Rate of Return = (Expected Dividend / Current Stock Price ) + Dividend Growth Rate

Required Rate of Return = (0.95 * 1.04 / 11.54) + 0.04
Required Rate of Return = 0.08639 or 8.64% + 4%
Required Rate of Return = 12.64%

Therefore, the correct answer is C) 12.6%.

Question 11

John requires a 12% rate of return on EG stock at a time when investors, on average, are requiring an 11% rate of return on the same stock.Which of the following will happen?

Accepted Answer

If John requires a higher rate of return than the market average, it means he is not willing to pay as much as other investors for the same stock. Therefore, if the price of the stock does not change, John will not be able to buy it at his required rate of return.

Question 12

In applying the variable-growth dividend valuation model to a company's stock, analysts frequently define the growth rate, g, as equal to

Accepted Answer

The variable-growth dividend valuation model assumes that the dividend grows at a variable rate, which is determined by the company's retention rate and return on equity (ROE). Therefore, the growth rate (g) is calculated as the product of ROE and retention rate.

Question 13

ABC Company stock currently has a market value equivalent to its intrinsic value.Marco perceives that ABC Company is increasing its level of risk and therefore Marco increases his required rate of return on ABC stock.This change in the required rate of return

Accepted Answer

If the market value of a stock is already equivalent to its intrinsic value, then any increase in the required rate of return will cause the intrinsic value to decrease. This is because a higher required rate of return implies a higher level of risk, which reduces the present value of future cash flows and lowers the intrinsic value. Therefore, choice A is the correct answer.

Question 14

One stock valuation model holds that the value of a share of stock is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time.This stock valuation model is known as the

Accepted Answer

The description given matches the constant growth dividend valuation model, also known as the Gordon Growth Model. This model assumes that the value of a stock is the present value of its expected future dividends, which grow at a constant rate.

Question 15

When using the constant-growth dividend valuation model, which of the following will lower the value of the stock?

Accepted Answer

According to the constant-growth dividend valuation model, as the required rate of return increases, the value of the stock decreases. This is because a higher required rate of return reflects a higher level of risk associated with the investment, and investors will only be willing to pay a lower price for the stock to compensate for that risk. The other choices, including a decrease in the required rate of return, an increase in the dividend payout ratio, and an increase in the growth rate of the dividends, would all lead to an increase in the stock's value according to the constant-growth dividend valuation model.

Question 16

The rate of growth can exceed the required return during the variable-growth period without invalidating the variable growth dividend valuation model.

Accepted Answer

The variable-growth dividend valuation model allows for the possibility that the rate of dividend growth may exceed the required return during the variable-growth period, as this is accounted for in the formula. Therefore, it does not invalidate the model.

Question 17

A company that wants to maintain both a constant growth rate in dividends and a constant payout ratio will have to

Accepted Answer

For a company to maintain both a constant growth rate in dividends and a constant payout ratio, it must grow its earnings at the same rate as dividends. This is because the payout ratio is the fraction of earnings paid out as dividends, so if both the payout ratio and the dividend growth rate are constant, earnings must grow at the same rate as dividends to sustain this balance.

Question 18

The rate of dividend growth can be estimated by multiplying the return on equity rate by the dividend payout ratio.

Accepted Answer

The rate of dividend growth is typically estimated using the retention ratio (the proportion of earnings not paid out as dividends) multiplied by the return on equity (ROE), not the dividend payout ratio. The dividend payout ratio is the proportion of earnings paid out as dividends to shareholders.

Question 19

James is willing to settle for a 10% rate of return on EG stock at a time when investors, on average, are requiring an 11% rate of return on the same stock.Which of the following will happen?

Accepted Answer

Since James is willing to settle for a 10% rate of return while investors on average are requiring an 11% rate of return, it implies that the price of the stock in the market is undervalued. Therefore, James will be happy to buy the stock for less than he was willing to pay.

Question 20

One method of estimating the dividend growth rate is to calculate the discount rate that equates today's dividend with the dividend paid several years ago.

Accepted Answer

This method is called the Dividend Discount Model or the Gordon Growth Model.

Quiz 8: Stock Valuation