50. Equity Valuation (Web + Sch Note)

Assuming the risk-free rate is 5% and the expected return on the market is 12%, what is the value of a stock with a beta of 1.5 that paid a $2 dividend last year if dividends are expected to grow at a 5% rate forever? A) $12.50. B) $17.50. C) $20.00.

C P0 = D1 / (k ? g) Rs = Rf + β(RM ? Rf) = 0.05 + 1.5(0.12 ? 0.05) = 0.155 D1 = D0(1 + g) = 2 × (1.05) = 2.10 P0 = 2.10 / (0.155 ? 0.05) = $20.00

An analyst studying Albion Industries determines that the average EV/EBITDA ratio for Albion's industry is 10. The analyst obtains the following information from Albion's financial statements: EBITDA = ￡11,000,000 Market value of debt = ￡30,000,000 Cash = ￡1,000,000 Based on the industry's average enterprise value multiple, what is the equity value of Albion Industries? A) ￡110,000,000. B) ￡80,000,000. C) ￡81,000,000.

C Enterprise value = Average EV/EBITDA × company EBITDA = 10 × ￡11,000,000 = ￡110,000,000 Enterprise value = Equity value + debt + cash Equity value = Enterprise value - debt + cash = ￡110,000,000 - ￡30,000,000 + ￡1,000,000 = ￡81,000,000

An equity valuation model that values a firm based on the market value of its outstanding debt and equity securities, relative to a firm fundamental, is a(n): A) asset-based model. B) market multiple model. C) enterprise value model.

C An enterprise value model relates a firm's enterprise value (the market value of its outstanding equity and debt securities minus its cash and marketable securities holdings) to its EBITDA, operating earnings, or revenue.

Which of the following is least likely a reason the price to cash flow (P/CF) model has grown in popularity? A) CFs are generally more difficult to manipulate than earnings. B) CFs are used extensively in valuation models. C) CFs are more easily estimated than future dividends.

C CFs are not easier to estimate than dividends.

One advantage of using price-to-book value (PBV) multiples for stock valuation is that: A) it is a stable and simple benchmark for comparison to the market price. B) most of the time it is close to the market value. C) book value of a firm can never be negative.

A Book value provides a relatively stable measure of value that can be compared to the market price. For investors who mistrust the discounted cash flow estimates of value, it provides a much simpler benchmark for comparison. Book value may or may not be closer to the market value. A firm may have negative book value if it shows accounting losses consistently.

An argument against using the price to cash flow (P/CF) valuation approach is that: A) non-cash revenue and net changes in working capital are ignored when using earnings per share (EPS) plus non-cash charges as an estimate. B) cash flows are not as easy to manipulate or distort as EPS and book value. C) price to cash flow ratios are not as volatile as price-to-earnings (P/E) multiples.

A Items affecting actual cash flow from operations are ignored when the EPS plus non-cash charges estimate is used. For example, non-cash revenue and net changes in working capital are ignored. Both remaining responses are arguments in favor of using the price to cash flow approach.

What is the value of a stock that paid a $0.25 dividend last year, if dividends are expected to grow at a rate of 6% forever? Assume that the risk-free rate is 5%, the expected return on the market is 10%, and the stock's beta is 0.5. A) $17.67. B) $16.67. C) $3.53.

A The discount rate is ke = 0.05 + 0.5(0.10 ? 0.05) = 0.075. Use the infinite period dividend discount model to value the stock. The stock value = D1 / (ke - g) = (0.25 × 1.06) / (0.075 - 0.06) = $17.67.

One advantage to using the price/book value (P/B) ratio over using the price/earnings (P/E) ratio is that P/B can be used when: A) earnings or cash flows are negative. B) stock markets are volatile. C) the firm is in a slow growth phase.

A When earnings are negative, P/E ratios cannot be used but P/B ratios can be used. The firm's rate of growth and the volatility of markets do not suggest advantages of using P/B ratios rather than P/E ratios.

Of the following types of firm, which is most suitable for P/B ratio analysis? A) A firm with accounting standards consistent to other firms. B) A firm with accounting standards different from other firms. C) A service industry firm without significant fixed assets.

A Assuming consistent accounting standards across firms, P/B ratios can reveal signs of misvaluation across firms.

Which of the following is NOT an advantage of using price-to-book value (PBV) multiples in stock valuation? A) Book values are very meaningful for firms in service industries. B) Book value is often positive, even when earnings are negative. C) PBV ratios can be compared across similar firms if accounting standards are consistent.

A Book values are NOT very meaningful for firms in service industries.

Which of the following is NOT an assumption of the constant growth dividend discount model (DDM)? A) The growth rate of the firm is higher than the overall growth rate of the economy. B) Dividend payout is constant. C) ROE is constant.

A Other assumptions of the DDM are: dividends grow at a constant rate and the growth rate continues for an infinite period.

Which of the following statements about the constant growth dividend discount model (DDM) in its application to investment analysis is least accurate? The model: A) is best applied to young, rapidly growing firms. B) can't be applied when g > K. C) is inappropriate for firms with variable dividend growth.

A The model is most appropriately used when the firm is mature, with a moderate growth rate, paying a constant stream of dividends. In order for the model to produce a finite result, the company's growth rate must not exceed the required rate of return.

An analyst has gathered the following data for Webco, Inc: Retention = 40% ROE = 25% k = 14% Using the infinite period, or constant growth, dividend discount model, calculate the price of Webco's stock assuming that next years earnings will be $4.25. A) $63.75. B) $55.00. C) $125.00.

A g = (ROE)(RR) = (0.25)(0.4) = 10% V = D1 / (k - g) D1 = 4.25 (1 ? 0.4) = 2.55 G = 0.10 K - g = 0.14 ? 0.10 = 0.04 V = 2.55 / 0.04 = 63.75

A firm will not pay dividends until four years from now. Starting in year four dividends will be $2.20 per share, the retention ratio will be 40%, and ROE will be 15%. If k = 10%, what should be the value of the stock? A) $41.32. B) $55.25. C) $58.89.

A g = ROE × retention ratio = ROE × b = 15 × 0.4 = 6% Based on the growth rate we can calculate the expected price in year 3: P3 = D4 / (k ? g) = 2.2 / (0.10 ? 0.06) = $55 The stock value today is: P0 = PV (55) at 10% for 3 periods = $41.32

The constant growth model requires which of the following? A. g < k. B. g > k. C. g k.

A For the constant growth model, the constant growth rate (g) must be less than the required rate of return (k).

Which of the following firms would most appropriately be valued using an asset-based model? A. An energy exploration firm in financial distress that owns drilling rights for offshore area. B. A paper firm located in a country that is experiencing high inflation. C. A software firm that invests heavily in research and development and frequently introduces new products.

A The energy exploration firm would be most appropriately valued using an asset-based model. Its near-term cash flows are likely negative, so a forward-looking model is of limited use. Furthermore, it has valuable assets in the form of drilling rights that likely have a readily determined market value. The paper firm would likely not be appropriately valued using an asset-based model because high inflation makes the values of a firm's assets more difficult to estimate. An asset-based model would not be appropriate to value the software firm because the firm's value largely consists of internally developed intangible assets.

Gwangwa Gold, a South African gold producer, has as its primary asset a mine which is shown on the balance sheet with a value of R100 million. An analyst estimates the market value of this mine to be 90% of book value. The company's balance sheet shows other assets of R20 million and liabilities of R40 million, and the analyst feels that the book value of these items reflects their market values. Using the asset-based valuation approach, what should the analyst estimate the value of the company to be? A) R80 million. B) R70 million. C) R110 million.

B Market value of assets = 0.9(R100 million) + R20 million = R110 million Market value of liabilities = R40 million Estimated net value of company = R110 million - R40 million = R70 million.

Which of the following statements concerning security valuation is least accurate? A) A stock to be held for two years with a year-end dividend of $2.20 per share, an estimated value of $20.00 at the end of two years, and a required return of 15% is estimated to be worth $18.70 currently. B) A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $36.11. C) A stock with an expected dividend payout ratio of 30%, a required return of 8%, an expected dividend growth rate of 4%, and expected earnings of $4.15 per share is estimated to be worth $31.13 currently.

B A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $37.33 using the DDM where Po = D1 / (k ? g). We are given Do = $3.25, g = 3.5%, and k = 12.5%. What we need to find is D1 which equals Do × (1 + g) therefore D1 = $3.25 × 1.035 = $3.36 thus Po = 3.36 / (0.125 ? 0.035) = $37.33. In the answer choice where the stock value is $18.70, discounting the future cash flows back to the present gives the present value of the stock. the future cash flows are the dividend in year 1 plus the dividend and value of the stock in year 2 thus the equation becomes: Vo = 2.2 / 1.15 + (2.2 + 20) / 1.152 = $18.70 For the answer choice where the stock value is $31.13 use the DDM which is Po = D1 / (k ? g). We are given k = 0.08, g = 0.04, and what we need to find is next year's dividend or D1. D1 = Expected earnings × payout ratio = $4.15 × 0.3 = $1.245 thus Po = $1.245 / (0.08 ? 0.04) = $31.13

If an analyst estimates the intrinsic value for a security that is different from its market value, the analyst should most likely take an investment position based on this difference if: A) many analysts independently evaluate the security. B) the model used is not highly sensitive to its input values. C) the security lacks a liquid market and trades infrequently.

B In general, an analyst can be more confident about an estimate of intrinsic value if the model used is not highly sensitive to changes in its inputs. If a large number of analysts follow a security, its market value is more likely to be a reliable estimate of its intrinsic value. A security that does not trade frequently or in a liquid market may remain mispriced for an extended time, and thus may not result in a profit within the investment horizon even if the analyst's estimate of intrinsic value is correct.

Which of the following statements regarding price multiples is most accurate? A) A disadvantage of the price/book value ratio is that it is not an appropriate measure for firms that primarily hold liquid assets. B) An advantage of the price/sales ratio is that it is meaningful even for distressed firms. C) A rationale for using the price/cash flow ratio is that there is only one clear definition of cash flow.

B The P/S ratio is meaningful even for distressed firms, since sales revenue is always positive. This is not the case for the P/E and P/BV ratios, which can be negative. In the P/BV ratio book value is an appropriate measure of net asset value for firms that primarily hold liquid assets. Analysts use several different definitions of cash flow (CFO, adjusted CFO, FCFE, EBITDA, etc.) to calculate P/CF ratios. When earnings are negative, the P/E ratio is meaningless.

Which of the following statements concerning security valuation is least accurate? A) The best way to value a company with no current dividend but who is expected to pay dividends in three years is to use the temporary supernormal growth (multistage) model. B) A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on equity of 12%, and a 15% required return is worth $18.24. C) The best way to value a company with high and unsustainable growth that exceeds the required return is to use the temporary supernormal growth (multistage) model.

B A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on new investment of 12%, and a 15% required return is worth $20.64. The growth rate is (1 - 0.40) × 0.12 = 7.2%. The expected dividend is then ($1.50)(1.072) = $1.61. The value is then (1.61) / (0.15 - 0.072) = $20.64.

Which of the following is least likely an advantage of using price/sales (P/S) multiple? A) P/S multiples provide a meaningful framework for evaluating distressed firms. B) P/S multiples are more reliable because sales data cannot be distorted by management. C) P/S multiples are not as volatile as P/E multiples and hence may be more reliable in valuation analysis.

B Accounting data on sales is used to calculate the P/S multiple. The P/S multiple is thought to be more reliable because sales figures are not as easy to manipulate as the earnings and book value, both of which are significantly affected by accounting conventions. However, it is not true that "sales data cannot be distorted by management" because aggressive revenue recognition practices can influence reported sales.

Given the following information, compute the implied dividend growth rate. Profit margin = 10.0% Total asset turnover = 2.0 times Financial leverage = 1.5 times Dividend payout ratio = 40.0% A) 4.5%. B) 18.0%. C) 12.0%.

B Retention ratio equals 1 - 0.40, or 0.60. Return on equity equals (10.0%)(2.0)(1.5) = 30.0%. Dividend growth rate equals (0.60)(30.0%) = 18.0%.

Use the following information and the multi-period dividend discount model to find the value of Computech's common stock. Last year's dividend was $1.62. The dividend is expected to grow at 12% for three years. The growth rate of dividends after three years is expected to stabilize at 4%. The required return for Computech's common stock is 15%. Which of the following statements about Computech's stock is least accurate? A) At the end of two years, Computech's stock will sell for $20.64. B) Computech's stock is currently worth $17.46. C) The dividend at the end of year three is expected to be $2.27.

B The dividends for years 1, 2, and 3 are expected to be ($1.62)(1.12) = $1.81; ($1.81)(1.12) = $2.03; and ($2.03)(1.12) = $2.27. At the end of year 2, the stock should sell for $2.27 / (0.15 - 0.04) = $20.64. The stock should sell currently for ($20.64 + $2.03) / (1.15)2 + ($1.81) / (1.15) = $18.71.

An analyst gathered the following information about a company: The stock is currently trading at $31.00 per share. Estimated growth rate for the next three years is 25%. Beginning in the year 4, the growth rate is expected to decline and stabilize at 8%. The required return for this type of company is estimated at 15%. The dividend in year 1 is estimated at $2.00. The stock is undervalued by approximately: A) $15.70. B) $6.40. C) $0.00.

B The high "supernormal" growth in the first three years and the decrease in growth thereafter signals that we should use a combination of the multi-period and finite dividend growth models (DDM) to value the stock. Step 1: Determine the dividend stream through year 4 D1 = $2.00 (given) D2 = D1 × (1 + g) = 2.00 × (1.25) = $2.50 D3 = D2 × (1 + g) = $2.50 × (1.25) = $3.13 D4 = D3 × (1 + g) = $3.13 × (1.08) = $3.38 Step 2: Calculate the value of the stock at the end of year 3 (using D4) P3 = D4 / (ke - g) = $3.38 / (0.15 - 0.08) = $48.29 Step 3: Calculate the PV of each cash flow stream at ke = 15%, and sum the cash flows. Note: We suggest you clear the financial calculator memory registers before calculating the value. The present value of: D1 = 1.74 = 2.00 / (1.15)1, or FV = -2.00, N = 1, I/Y = 15, PV = 1.74 D2 = 1.89 = 2.50 / (1.15)2, or FV = -2.50, N = 2, I/Y = 15, PV = 1.89 D3 = 2.06 = 3.13 / (1.15)3, or FV = -3.13, N = 3, I/Y = 15, PV = 2.06 P3 = 31.75 = 48.29 / (1.15)3, or FV = -48.29, N = 3, I/Y = 15, PV = 31.75 Sum of cash flows = 37.44. Thus, the stock is undervalued by 37.44 - 31.00 = approximately 6.40. Note: Future values are entered in a financial calculator as negatives to ensure that the PV result is positive. It does not mean that the cash flows are negative. Also, your calculations may differ slightly due to rounding. Remember that the question asks you to select the closest answer.

Regarding the estimates required in the constant growth dividend discount model, which of the following statements is most accurate? A) Dividend forecasts are less reliable than estimates of other inputs. B) The model is most influenced by the estimates of "k" and "g." C) The variables "k" and "g" are easy to forecast.

B The relationship between "k" and "g" is critical - small changes in the difference between these two variables results in large value fluctuations.

Use the following information and the dividend discount model to find the value of GoFlower, Inc.'s, common stock. Last year's dividend was $3.10 per share. The growth rate in dividends is estimated to be 10% forever. The return on the market is expected to be 12%. The risk-free rate is 4%. GoFlower's beta is 1.1. A) $34.95. B) $121.79. C) $26.64.

B The required return for GoFlower is 0.04 + 1.1(0.12 - 0.04) = 0.128 or 12.8%. The expect dividend is ($3.10)(1.10) = $3.41. GoFlower's common stock is then valued using the infinite period dividend discount model (DDM) as ($3.41) / (0.128 - 0.10) = $121.79.

One advantage of price/sales (P/S) multiples over price to earnings (P/E) and price-to-book value (PBV) multiples is that: A) P/S is easier to calculate. B) P/S can be used for distressed firms. C) Regression shows a strong relationship between stock prices and sales.

B Unlike the PBV and P/E multiples, which can become negative and not meaningful, the price/sales multiple is meaningful even for distressed firms (that may have negative earnings or book value).

An analyst estimates that a stock will pay a $2 dividend next year and that it will sell for $40 at year-end. If the required rate of return is 1 5%, what is the value of the stock? A. $33.54. B. $36.52. C. $43.95.

B ($40 + $2) / 1.15 = $36.52

An analyst estimates a value of $45 for a stock with a market price of $50. The analyst is most likely to conclude that a stock is overvalued if: A. few analysts follow the stock and the analyst has less confidence in his model inputs. B. few analysts follow the stock and the analyst is confident in his model inputs. C. many analysts follow the stock and the analyst is confident in his model inputs.

B If the analyst is more confident of his input values, he is more likely to conclude that the security is overvalued. The market price is more likely to be correct for a security followed by many analysts and less likely correct when few analysts follow the security.

Which of the following firms would most likely be appropriately valued using the constant growth DDM? A. An auto manufacturer. B. A producer of bread and snack foods. C. A biotechnology firm in existence for two years.

B The constant growth DDM assumes that the dividend growth rate is constant. The most likely choice here is the bread and snack producer. Auto manufacturers are more likely to be cyclical than to experience constant growth. A biotechnology firm in existence for two years is unlikely to pay a dividend, and if it does, dividend growth is unlikely to be constant.

Which of the following is least likely a rationale for using price multiples? A. Price multiples are easily calculated. B. The fundamental P/E ratio is insensitive to its inputs. C. The use of forward values in the divisor provides an incorporation of the future.

B The fundamental P/E ratio is sensitive to its inputs. It uses the DDM as its framework, and the denominator k- g in both has a large impact on the calculated P/E or stock value.

What is the intrinsic value of a company's stock if dividends are expected to grow at 5%> the most recent dividend was $1, and investors' required rate of return for this stock is 10%? A. $20.00. B. $21.00. C. $22.05.

B Using the constant growth model, $1(1.05) / (0.10- 0.05) = $21.00.

Next year's dividend is expected to be $2, g = 7%, and k = 12%. What is the stock's intrinsic value? A. $28.57. B. $40.00. C. $42.80.

B Using the constant growth model, $2 / (0.12- 0.07) = $40.00.

A firm has an expected dividend payout ratio of 60% and an expected future growth rate of7%. What should the firm's fundamental price-to-earnings (P/E) ratio be if the required rate of return on stocks of this type is 15%? A. 5.0x. B. 7.5x. C. lO.Ox.

B Using the earnings multiplier model, 0.6 / (0.15 - 0.07) = 7.5x.

The XX Company paid a $1 dividend in the most recent period. The company is expecting dividends to grow at a 6% rate into the future. What is the value of this stock if an investor requires a 15% rate of return on stocks of this risk class? A. $10.60. B. $11.11. C. $11.78.

C Using the constant growth model, $1(1.06) / (0.15 - 0.06) = $11.78.

Given the following estimated financial results, value the stock of FishnChips, Inc., using the infinite period dividend discount model (DDM). Sales of $1,000,000. Earnings of $150,000. Total assets of $800,000. Equity of $400,000. Dividend payout ratio of 60.0%. Average shares outstanding of 75,000. Real risk free interest rate of 4.0%. Expected inflation rate of 3.0%. Expected market return of 13.0%. Stock Beta at 2.1. The per share value of FishnChips stock is approximately: (Note: Carry calculations out to at least 3 decimal places.) A) Unable to calculate stock value because ke < g. B) $17.91. C) $26.86.

C Here, we are given all the inputs we need. Use the following steps to calculate the value of the stock: First, expand the infinite period DDM: DDM formula: P0 = D1 / (ke - g) ***D1 = (Earnings × Payout ratio) / average number of shares outstanding> > = ($150,000 × 0.60) / 75,000 = $1.20 ***ke = nominal risk free rate + [beta × (expected market return - nominal risk free rate)] Note: Nominal risk-free rate = (1 + real risk free rate) × (1 + expected inflation) - 1 = (1.04)×(1.03) - 1 = 0.0712, or 7.12%. ke = 7.12% + [2.1 × (13.0% ? 7.12%)] =0.19468 ***g = (retention rate × ROE) Retention = (1 - Payout) = 1 - 0.60 = 0.40. ROE = (net income / sales)(sales / total assets)(total assets / equity) = (150,000 / 1,000,000)(1,000,000 / 800,000)(800,000 / 400,000) = 0.375 g = 0.375 × 0.40 = 0.15 Then, calculate: P0 = D1 / (ke - g) = $1.20 / (0.19468 ? 0.15) = 26.86.

The constant-growth dividend discount model would typically be most appropriate in valuing a stock of a: A) rapidly growing company. B) new venture expected to retain all earnings for several years. C) moderate growth, "mature" company.

C Remember, the infinite period DDM has the following assumptions: The stock pays dividends and they grow at a constant rate. The constant growth rate, g, continues for an infinite period. k must be greater than g. If not, the math will not work. If any one of these assumptions is not met, the model breaks down. The infinite period DDM doesn't work with growth companies. Growth companies are firms that currently have the ability to earn rates of return on investments that are currently above their required rates of return. The infinite period DDM assumes the dividend stream grows at a constant rate forever while growth companies have high growth rates in the early years that level out at some future time. The high early or supernormal growth rates will also generally exceed the required rate of return. Since the assumptions (constant g and k > g) don't hold, the infinite period DDM cannot be used to value growth companies.

Which of the following is a disadvantage of using price-to-sales (P/S) multiples in stock valuations? A) It is difficult to capture the effects of changes in pricing policies using P/S ratios. B) P/S multiples are more volatile than price-to-earnings (P/E) multiples. C) The use of P/S multiples can miss problems associated with cost control.

C Due to the stability of using sales relative to earnings in the P/S multiple, an analyst may miss problems of troubled firms concerning its cost control. P/S multiples are actually less volatile than P/E ratios, which is an advantage in using the P/S multiple. Also, P/S ratios provide a useful framework for evaluating effects of pricing changes on firm value.

An argument against using the price-to-earnings (P/E) valuation approach is that: A) research shows that P/E differences are significantly related to long-run average stock returns. B) earnings power is the primary determinant of investment value. C) earnings can be negative.

C Negative earnings render the P/E ratio useless. Both remaining factors increase the usefulness of the P/E approach.

The price to book value ratio (P/BV) is a helpful valuation technique when examining firms: A) with older assets compared to those with newer assets. B) with the same stock prices. C) that hold primarily liquid assets.

C P/BV analysis works best for firms that hold primarily liquid assets.

Which of the following is a disadvantage of using the price-to-book value (PBV) ratio? A) Book value may not mean much for manufacturing firms with significant fixed costs. B) Firms with negative earnings cannot be evaluated with the PBV ratios. C) Book values are affected by accounting standards, which may vary across firms and countries.

C The disadvantages of using PBV ratios are: Book values are affected by accounting standards, which may vary across firms and countries. Book value may not mean much for service firms without significant fixed costs. Book value of equity can be made negative by a series of negative earnings, which limits the usefulness of the variable.

Assume that a stock paid a dividend of $1.50 last year. Next year, an investor believes that the dividend will be 20% higher and that the stock will be selling for $50 at year-end. Assume a beta of 2.0, a risk-free rate of 6%, and an expected market return of 15%. What is the value of the stock? A) $45.00. B) $40.32. C) $41.77.

C Using the Capital Asset Pricing Model, we can determine the discount rate equal to 0.06 + 2(0.15 - 0.06) = 0.24. The dividends next year are expected to be $1.50 × 1.2 = $1.80. The present value of the future stock price and the future dividend are determined by discounting the expected cash flows at the discount rate of 24%: (50 + 1.8) / 1.24 = $41.77.

An argument against using the price-to-sales (P/S) valuation approach is that: A) P/S ratios are not as volatile as price-to-earnings (P/E) multiples. B) sales figures are not as easy to manipulate or distort as earnings per share (EPS) and book value. C) P/S ratios do not express differences in cost structures across companies.

C P/S ratios do not express differences in cost structures across companies. Both remaining responses are advantages of the P/S ratios, not disadvantages.

An analyst feels that Brown Company's earnings and dividends will grow at 25% for two years, after which growth will fall to a constant rate of 6%. If the projected discount rate is 10%, and Brown's most recently paid dividend was $1, the value of Brown's stock using the multistage dividend discount model is closest to: A. $31.25. B. $33.54. C. $36.65.

C $1(1.25) / 1.1 + [$1(1.25)2/ (0.10-0.06)] / 1.1 = $36.65.

Assume that a stock is expected to pay dividends at the end of Year 1 and Year 2 of $1.25 and $1.56, respectively. Dividends are expected to grow at a 5% rate thereafter. Assuming that kt is 11%, the value of the stock is closest to: A. $22.30. B. $23.42. C. $24.55.

C ($1.25 / 1.11) + [1.56/ (0.11 -0.05)] / 1.11 = $24.55.

What would an investor be willing to pay for a share of preferred stock that pays an annual $7 dividend if the required return is 7.75%? A. $77.50. B. $87.50. C. $90.32.

C The share value is 7.0 / 0.0775 = $90.32.