Corporate Finance MGMT 332 Chapter 7

Suppose a firm's dividends are expected to grow at a rate of 15% (g1) for 3 years (t) then stabilize at 5% (g2) forever. If the firm just paid a $2.00 (D0) dividend and the discount rate is 10% (r), what is the value of a share of the firm's stock in year 3 (P3)? (Do not round your intermediate calculation.)

D3 = D x (1+g1)t = 2X(1.15)^3 = 3.04 D4 = D3 x (1+g2) = 3.04 X 1.05 = 3.19 P3 = D4/(r-g2) = 3.19/(0.10-0.05) = 63.88

A zero-growth stock pays a diffident of $2 per share and has a discount rate of 10%. What will the stock's price be?

Po = $2/0.10 = $20

Which of the following are reasons that make valuing a share of stock more difficult than valuing a bond?

Stock has no set maturity *required rate of return is unobservable *dividends are unknown and uncertain

The NYSE differs from the NASDAQ primarily because the NYSE has :

a physical location; face to face auction market

A person who brings buyers and sellers together

broker

NASDAQ has which of these features?

computer network of securities dealers; multiple market maker system

A PE ratio that is based on estimated future earnings is known as a ---- PE ratio.

forward

The value of a firm is derived using the firm's ---- rate and its ---- rate.

growth;discount

What is the total return for a stock that currently sells for $50, just paid a $1.75 dividend, and has a constant growth rate of 8%

R = $1.75 x (1.08)/$50 + 0.08 = 11.78%

Preferred stock has preference over common stock in the:

distribution of corporate assets; payment of dividends

If unpaid preferred dividends must be "caught up" before any common dividends can be paid, they are called ---- dividends.

cumulative

All else constant, the dividend yield will increase if the stock price ---.

decreases

The constant-growth model assumes that ----.

dividends change at a constant rate

The ---- can be interpreted as the capital gains yield.

growth rate

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:

one vote per share held

Which of the following ratios might be used to estimate the value of a stock?

price/sales ratio price/earnings ratio

Initial public offerings of stock occur in the ____ market.

primary

NYSE Market Makers (MM) were formerly called ---.

specialists

Rights of common stock holders

*The right to share proportionally in any common dividends paid. *The right to vote on matters of importance *The right to share proportionally in any residual value in the event of liquidation

Which of the following are cash flows to investors in stocks?

Capital gains; dividends

Websites that allow investors to trade directly with one another are termed ----.

ECNs

Which of the following represents the valuation of stock using a zero growth model?

Dividend/Discount rate = D/R

What is the total return for a stock that currently sells for $100, is expected to pay a dividend in one year of $2, and has a constant growth rate of 8%?

10%

What is the price of a stock at the end of one year (P1) if the dividend for year 2 (D2) is $5, the price for year 2 (p2) is $20, and the discount rate is 10%?

2.P1 = $5+$20/1.10 = $22.73

Which one of the following is true about dividend growth patterns?

May grow at a constant rate.

The two most important stock markets in the US are the NYSE and

NASDAQ

For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

False

If the growth rate (g) is zero, the capital gains yield is ----.

zero

What information do we need to determine the value of a stock using the zero growth model?

Dividend; Discount rate

The price of a share of common stock is equal to the present value of all ---- future dividends.

Expected/future

A benchmark PE ratio can be determined using:

a company's own historical PEs the PEs of similar companies

If a company's growth for years 1 through 3 is 20% but stabilizes at 5% beginning in year 4, its growth pattern would be described as ----.

non-constant

This type of growth describes a company that grows quickly at first, then slower in future years.

non-constant

The fundamental business of the NYSE is to attract ----

order flow

Shares of stock are first brought to the market and sold to investors in the ---- market.

primary

Using a benchmark PE ratio against current earnings yields a forecasted price called a ---- price.

target

The dividend yield is determined by dividing the expected dividend (D1) by:

the current price (P0)