Ch. 7 Finance Test 2

41) Ria's Doll Company has an outstanding preferred issue of stock with a par value of $100 and an annual dividend of 10 percent (of par). Similar risk preferred stocks are yielding an 11.5 percent annual rate of return. (a) What is the current value of the outstanding preferred stock? (b) What will happen to price as the risk-free rate increases? Explain.

(a) Current value of the outstanding preferred stock = $100 × 0.10 / 0.115 = $86.96 (b) As the risk-free rate increases, the required rate of return will increase and the price will drop.

50) China America Manufacturing has a beta of 1.50, the risk-free rate of interest is currently 12 percent, and the required return on the market portfolio is 18 percent. The company plans to pay a dividend of $2.45 per share in the coming year and anticipates that its future dividends will increase at an annual rate consistent with that experienced over the 2001-2003 period. 2014-2.32 2013-2.21 2012-2.10 1)Estimate the value of China America Manufacturing's stock. 2)Growth rate of dividends:

1) = 0.12 + 1.50 (0.18 - 0.12) = 0.21 2) (2.32/2.1)^(1/2) -1=.0511% 2.45/(.21-.0511) = 15.42

2014-2.89 2013-2.53 2012-2.22 2011-1.95 2010-1.71 2009-1.5 Xiao Xin owns stock in a company which has paid the annual dividends shown in 47)Calculate the growth rate of these dividends. 48) Calculate the estimated dividend for 2015. 49) The required return is assumed to be 17 percent. Using the Gordon model, calculate the per share value of the stock for 2014.

47)(2.89 / 1.5)^1/5 - 1 = 0.14 = 14% 48)= ($2.89) × (1.14) = $3.29 49)3.29/(.17-.14)=109.67

30) Julian is considering purchasing the stock of Pepsi Cola because he really loves the taste of Pepsi. What should Julian be willing to pay for Pepsi today if it is expected to pay a $2 dividend in one year and he expects dividends to grow at 5 percent indefinitely? Julian requires a 12 percent return to make this investment. A) $28.57 B) $29.33 C) $31.43 D) $43.14

A

31) Harry Corporation's common stock currently sells for $180 per share. Harry just paid a dividend of $10.18 and dividends are expected to grow at a constant rate of 6 percent forever. If the required rate of return is 12 percent, what will Harry Corporation's stock sell for one year from now? A) $190.64 B) $187.04 C) $195.40 D) $179.84

A

32) Tangshan China Company's stock is currently selling for $80.00 per share. The expected dividend one year from now is $4.00 and the required return is 13 percent. What is Tangshan's dividend growth rate assuming that dividends are expected to grow at a constant rate forever? A) 8% B) 9% C) 10% D) 11%

A

18) If the expected return is above the required return on an asset, rational investors will ________. A) buy the asset, which will drive the price up and cause expected return to reach the level of the required return B) buy the asset, which will drive the price down and cause the expected return to reach the level of the required return C) sell the asset, which will drive the price up and cause the expected return to reach the level of the required return D) sell the asset, since price is expected to decrease

A Diff: 2

17) If expected return is less than required return on an asset, rational investors will ________. A) buy the asset, which will drive the price up and cause expected return to reach the level of the required return B) sell the asset, which will drive the price down and cause the expected return to reach the level of the required return C) sell the asset, which will drive the price up and cause the expected return to reach the level of the required return D) buy the asset, since price is expected to increase

B

26) Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of dividends of 10 percent, and a required return of 20 percent. The value of a share of Emmy Lou, Inc.'s common stock is ________. A) $28.00 B) $56.00 C) $22.40 D) $18.67

B

33) Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. Assuming Tangshan China's most recent dividend was $5.50, what is the required rate of return on Tangshan's stock? A) 7.3% B) 8.4% C) 9.5% D) 10.6%

B

15) Rational buyers and sellers use their assessment of an asset's risk and return to determine its value. Relative to this concept, which of the following is true? A) To a buyer the asset's value represents the minimum price that he or she would pay to acquire it. B) To a seller the asset's value represents the maximum sale price. C) To a buyer the asset's value represents the maximum price that he or she would pay to acquire it. D) To a seller the asset's value represents the price at which he acquired the asset.

C

16) According to the efficient market hypothesis, prices of actively traded stocks ________. A) can be under- or over-valued in an efficient market B) can only be under-valued in an efficient market C) do not differ from their true values in an efficient market D) can only be over-valued in an efficient market

C

20) Preferred stock is valued as if it were a ________. A) fixed-income obligation B) bond C) perpetuity D) common stock

C

21) A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4. The required return on the preferred stock has been estimated to be 16 percent. The value of the preferred stock is ________. A) $64 B) $16 C) $25 D) $50

C

22) A firm has to pay a dividend of $1.20 per share till perpetuity, a zero growth rate of dividends, and a required return of 10 percent. The value of the firm's preferred stock is ________. A) $120 B) $10 C) $12 D) $100

C

23) A firm has an issue of preferred stock outstanding that has a par value of $100 and a 4% dividend. If the current market price of the preferred stock is $50, the yield on the preferred stock is ________. A) 4.00% B) 6.00% C) 8.00% D) 12.00%

C

27) A firm has experienced a constant annual rate of dividend growth of 9 percent on its common stock and expects the dividend per share in the coming year to be $2.70. The firm can earn 12 percent on similar risk involvements. The value of the firm's common stock is ________. A) $22.50/share B) $9/share C) $90/share D) $30/share

C

35) Jia's Fashions recently paid a $2 annual dividend. The company is projecting that its dividends will grow by 20 percent next year, 12 percent annually for the two years after that, and then at 6 percent annually thereafter. Based on this information, how much should Jia's Fashions common stock sell for today if her required return is 10.5%? A) $54.90 B) $60.80 C) $59.16 D) $69.30

C

4) The ________ is utilized to value preferred stock. A) capital asset pricing model B) arbitrage pricing model C) zero-growth model D) Black-Scholes model

C

28) You are planning to purchase the stock of Ted's Sheds Inc. and you expect it to pay a dividend of $3 in 1 year, $4.25 in 2 years, and $6.00 in 3 years. You expect to sell the stock for $100 in 3 years. If your required return for purchasing the stock is 12 percent, how much would you pay for the stock today? A) $75.45 B) $77.24 C) $81.52 D) $85.66

C Diff: 1

46) The Oxford Heating Company has been very successful in the past four years. Over these years, it paid common stock dividend of $4 in the first year, $4.20 in the second year, $4.41 in the third year, and its most recent dividend was $4.63. The company wishes to continue this dividend growth indefinitely. What is the value of the company's stock if the required rate of return is 12 percent?

Constant growth rate, g = ($4.63 / $4.00)1/3 - 1 = 0.04996, g = 5% P = D5 / (r - g) = 4.63 (1 + 0.05) / (0.12 - 0.05) = $69.45

25) In the Gordon model, the value of a common stock is the ________. A) net value of all assets which are liquidated for their exact accounting value B) actual amount each common stockholder would expect to receive if the firm's assets are sold C) present value of a non-growing dividend stream D) present value of a constant growing dividend stream

D

29) Smith Corporation's common stock is expected to pay a dividend of $3.00 forever and currently sells for $21.42. What is the required rate of return? A) 10% B) 12% C) 13% D) 14%

D

34) Daniel Custom Cycles' common stock currently pays no dividends. The company plans to begin paying dividends beginning 3 years from today. The first dividend will be $3.00 and dividends will grow at 5 percent per year thereafter. Given a required return of 15 percent, what would you pay for the stock today? A) $25.33 B) $18.73 C) $29.86 D) $22.68

D

as a result, it would be worthwhile for investors should spend time searching for mispriced (over- or under-valued) stocks. C) At any point in time, security prices fully reflect all internal information available about the firm and its securities, and these prices are insensitive to new information. D) Since stocks are fully and fairly priced, it follows that investors should not waste their time trying to find and capitalize on miss-priced (undervalued or overvalued) securities.

D Diff: 1 Topic: The Efficient-Market Hypothesis Learning Obj.: LG 4 Learning Outcome: F-01

43) The Bradshaw Company's most recent dividend was $6.75. The historical dividend payment by the company shows a constant growth rate of 5 percent per year. What is the maximum you would be willing to pay for a share of its common stock if your required rate of return is 8 percent?

D1 = $6.75 × (1 + 0.05) = $7.0875 P = D1 / (r - g) = $7.0875/(0.08 - 0.05) = $236.25

42) Ted has 10 shares of Grand Company. Based on the company's dividend policy, Ted will receive a total of $450 a year in perpetuity. What is the value of each share if the rate of interest is 8 percent?

Dividend per share = $450 / 10 = $45 P = D / r = 45 / 0.08 = $562.50

38) Aunt Tilly's Fur Company has been experiencing several years of financial difficulty and, thus, has considered maintaining its dividend payment at $2.50 indefinitely. What is the value of its common stock if the required rate of return is 8.5 percent?

P = D / r = $2.50 / 0.085 = $29.41

36) The board of directors of Ride World, Inc. has declared $5.00 common stock dividend and accepted a plan to freeze the dividend at $5 per year indefinitely. What is the value of the Ride World's common stock if the required rate of interest is 15 percent?

P = D / r = $5 / 0.15 = $33.33

37) Jia's Kitchen Stuff has recently sold 1,000 shares of preferred stock. What is the value of the stock assuming 10 percent required rate of return and a preferred dividend of $6.75?

P = D / r = $6.75 / 0.10 = $67.50

44) Tina's Medical Equipment Company paid $2.25 common stock dividend last year. The company's policy is to allow its dividend to grow at 5 percent per year indefinitely. What is the value of the stock if the required rate of return is 8 percent?

P = D1 / (r - g) = $2.25 × (1 + 0.05) / (0.08 - 0.05) = $78.75

39) In response to the stock market's reaction to its dividend policy, the Nico's Toy Company has decided to increase its dividend payment at a rate of 4 percent per year. The firm's most recent dividend is $3.25 and the required rate of interest is 9 percent. What is the maximum you would be willing to pay for a share of the stock?

P = D1 / (r - g) = 3.25 × (1 + 0.04) / (0.09 - 0.04) = $67.60

51) Julie's X-Ray Company paid $2.00 per share in common stock dividends last year. The company's policy is to allow its dividend to grow at 5 percent for 4 years and then the rate of growth changes to 3 percent per year from year five and on. What is the value of the stock if the required rate of return is 8 percent?

P1-=7.46 D5= 2.43(1+.03)=2.5 P2= {2.5/(.08-.03)}x{1/(1+.08)^4}=36.81

52) Compute the value of a share of common stock of Lexi's Cookie Company whose most recent dividend was $2.50 and is expected to grow at 3 percent per year for the next 5 years, after which the dividend growth rate will increase to 6 percent per year indefinitely. Assume 10 percent required rate of return.

P1=10.31 D6=2.90 (1 + 0.06) = $3.07 P2= 3.07/(.1-.06) × 1/(1+.1)^5 = $47.69 Value of stock=47.66+10.32= 57.99

40) Uncle Tim's Inventions has an expected dividend next year of $3.60 and a required return of 12 percent. Assuming the dividends will be paid indefinitely, calculate the value of a share of common stock assuming a zero growth rate of dividends.

The value of a share of common stock = 3.60/.12= $30

45) Angel recently purchased a block of 100 shares of Hayley's Optical common stock for $6,000. The stock is expected to provide an annual cash flow of dividends of $400 indefinitely. Assuming a discount rate of 8 percent, how does the price Angel paid compare to the value of the stock?

The value of the stock is = 400/.08= $5,000