Ch 6 Stock Evaluation

A stock quote shows a last price of 32.13, a P/E of 17, and a net change of −.23. Based on this information, which one of the following statements is correct?

The earnings per share are equal to 1/17th of $32.13.

Corporate dividends

are taxed at the personal level even though they are paid from after-tax income.

Primary Colors has a debt-equity ratio of 0.56, a return on assets of 8.2 percent, and a dividend payout ratio of 45 percent. What is the firm's rate of growth?

g = (1 − 0.45) × [0.082 × (1 + 0.56)] = 0.0704, or 7.04%

Which of these factors are most associated with a high PE ratio?

Conservative accounting practices and low risk

Shares of ABBO stock are currently selling for $14.43 a share. The last annual dividend paid was $1.61 a share, and dividends increase at a constant rate. If the market rate of return is 14 percent, what is the dividend growth rate?

$14.43 = [$1.61 × (1 + g)] / (0.14 − g) g = 0.0256, or 2.56% Growth rate = 2.56% Explanation: Using the divided growth model P = D× (1+g)/(ke-g) P- price of stock, g- annual growth rate, Do- last dividend paid, Ke- market return Substituting, we have 14.43 = 1.61(1+g)/(0.14-g) cross multiplying =14.43× (0.14-g) = 1.61 + 1.61g 2.0202- 14.43g = 1.61 + 1.61g 2.0202 -1.61 = 1.61g + 14.43g 0.4102 =16.04g g = 0.025573566 × 100 Growth rate = 2.56%

An investor wants to purchase shares in a firm that has no growth opportunities but pays an annual dividend of $2.35. The market rate of return on similar securities is 17.5 percent. What is the maximum price the investor should pay for this stock?

$2.35 / 0.175 = $13.43

The rate at which a stock's price is expected to appreciate (or depreciate) is called the _____ yield.

Capital Gains

The total return on a stock is equal to

Capital gains yield + Dividend yield.

The voting procedure whereby shareholders may cast all of their votes for one candidate for the board of directors is called _____ voting.

Cumulative

The EV/EBITDA ratio has an advantage over the PE ratio in situations where comparisons are being made of firms that vary based on their

Degree of Leverage

Janlea Co. had total net earnings of $158,600 this past year and paid out 60 percent of those earnings in dividends. There are 84,000 shares of stock outstanding at a current market price of $18.43 a share. If the dividend growth rate is 2.8 percent, what is the required rate of return?

Dividend per share = (0.60 × $158,600) / 84,000 = $1.13286 R = $1.13286 / $18.43 + 0.028 = 0.0895, or 8.95%

According to finance professionals, which one of these factors has the biggest impact on a firm's PE ratio?

Growth opportunities

Lassiter Motors has a debt-equity ratio of 0.45 and total debt of $186,000. The firm's market-to-book ratio is 2.6. The earnings before interest and taxes is $69,200, interest is $26,400, depreciation and amortization total $87,100, and the tax rate is 34 percent. What is the firm's EV to EBITDA ratio if the firm has $31,000 in cash?

Market value of equity = ($186,000 / 0.45) × 2.6 = $1,074,666.67 EV/EBITDA = ($1,074,666.67 + $186,000 − $31,000) / ($69,200 + $87,100) = 7.87

Poplar Trees Inc. has 48,300 shares of stock outstanding, and each share receives one vote for each open seat on the board of directors. There are five open seats at this time. How many shares must you control if the firm uses straight voting to guarantee your personal election to the board?

Number of shares required = (0.5 × 48,300) + 1 = 24,151 shares

General Stores recently announced that it will pay annual dividends of $1.05, $.80, and $.50 over the next 3 years, respectively. The following year, the firm will close and pay a final dividend of $11.30 a share. What is one share of this stock worth today at a discount rate of 16.6 percent?

P0 = $1.05 / 1.166 + $0.80 / 1.166^2 + $0.50 / 1.166^3 + $11.30 / 1.166^4 = $7.92

Last week, Railway Cabooses paid its annual dividend of $1.12 a share. The company has been reducing its dividends by 4 percent each year. What is one share of stock worth at a required return of 17 percent?

P0 = {$1.12 × [1 + (−0.04)]} / [0.17 − (−0.04)] = $5.12

Webster preferred stock pays an annual dividend of $6.20 a share. What is the maximum price you should pay today to purchase this stock if you desire a rate of return of 14.25 percent?

P0= $6.20 / 0.1425 = $43.51

Mario's is going to pay $1, $2.65, and $4 a share over the next 3 years, respectively. After that, the company plans to pay annual dividends of $1.65 per share indefinitely. If your required return is 14 percent, how much are you willing to pay for one share today?

P3 = $1.65 / 0.14 = $11.79 P0 = $1 / 1.14 + $2.65 / 1.142 + ($4 + 11.79) / 1.143 = $13.57

New Tours last annual dividend was $2 a share. The company plans to lower the dividend by $.30 each year for the next 3 years. In Year 5, it will pay a final liquidating dividend of $17 a share. If the required return is 22 percent, what is the current per share value of this stock?

P3 = $2 / 0.17 = $11.76 P0 = $4 / 1.172 + ($4 + 11.76) / 1.173 = $12.77`

Dille Inc. pays no dividend at the present time. In Years 2 and 3, the firm will pay annual dividends of $4 a share. After that, it will pay a constant $2 a share dividend indefinitely. What is this stock worth at a required return of 17 percent?

P3 = $2 / 0.17 = $11.76 P0 = $4 / 1.17^2 + ($4 + 11.76) / 1.17^3 = $12.77

The Extreme Reaches Corp.'s last annual dividend was $1.98 per share. The company is planning on paying $2, $2, $2.50, and $3 a share over the next 4 years, respectively. After that, the dividend will be a constant $2.50 per share per year. What is the current price of this stock if the rate of return is 13 percent?

P4 = $2.50 / 0.13 = $19.23 P0 = $2 / 1.13 + $2 / 1.13^2 + $2.50 / 1.13^3 + ($3 + 19.23) / 1.13^4 P0 = $18.70

XanEx is a new firm that just paid an annual dividend of $1 a share. The firm plans to increase its dividend by 10 percent a year for the next 4 years and then decrease the growth rate to 2 percent annually. If the required rate of return is 18.25 percent, what is one share of this stock worth today?

P4 = ($1 × 1.14 × 1.02) / (0.1825 − 0.02) = $9.19 P0 = ($1 × 1.1) / 1.1825 + ($1 × 1.12) / 1.18252 + ($1 × 1.13) / 1.18253 + [($1 × 1.14) + $9.19] / 1.18254 P0 = $8.05 D0 = $1.00growth rate for first 4 years is 10% and 2% after that D1 = $1.0000 * 1.10 = $1.1000D2 = $1.1000 * 1.10 = $1.2100D3 = $1.2100 * 1.10 = $1.3310D4 = $1.3310 * 1.10 = $1.4641D5 = $1.4641 * 1.02 = $1.4934 Required return, r = 18.25%constant growth rate, g = 2% P4 = D5 / (r - g)P4 = $1.4934 / (0.1825 - 0.02)P4 = $9.1900 P0 = $1.1000/1.1825 + $1.2100/1.1825^2 + $1.3310/1.1825^3 + $1.4641/1.1825^4 + $9.1900/1.1825^4P0 = $8.06 So, current price is $8.06

Wilton's Market just announced its next annual dividend will be $1.62 a share with future dividends increasing by 2.2 percent annually. How much will one share of this stock be worth 6 years from now if the required return is 12.5 percent?

P6 = ($1.62 × 1.022^6) / (0.125 − 0.022) = $17.92

Which one of the following statements concerning preferred stock is correct?

Preferred shareholders may be granted voting rights if preferred dividend payments remain unpaid.

Blasco just paid an annual dividend of $1.63 a share. What is one share of this stock worth to you if the dividends increase by 3 percent annually and you require a rate of return of 14 percent?

Price of the stock today=D1/(r-g) where: D1=next dividend payment r=interest rate g=firm's expected growth rate Price of the stock today= $1.63*(1 + 0.03)/ 0.14 - 0.03 = $1.6789/ 0.11 = $15.2627 $15.26.

What is the primary role of a designated market maker (DMM)?

Provide a two-sided market

The voting procedure where a shareholder grants authority to another individual to vote his/her shares is called _____ voting.

Proxy

Which one of these formulas is used to estimate a firm's growth rate?

Retention ratio x ROE

Jack owns shares of stock in Boynton Foods and wants to be elected to the company's board of directors. There are 10,000 shares of stock outstanding and each share is granted one vote for each open position on the board. Presently, the company is voting to elect two new directors. Jack can be assured of his election

if cumulative voting applies and he owns one-third of the shares, plus one additional share.

The owner of preferred stock

is entitled to a distribution of income prior to the common shareholders.

Alto stock pays an annual dividend of $1.10 a share and has done so for the past 6 years. No changes in the dividend amount are expected. The relevant market rate of return is 7.8 percent. Given this, one share of this stock

is valued as a perpetuity.

The underlying assumption of the dividend growth model is that a stock is worth

the present value of the future income provided by that stock.