FIN 3414 - Chapter 6

The two components of the dividend growth model are the dividend yield and growth rate (capital gains yield). How is the dividend yield calculated in this model?

Expected cash dividend divided by the current price.

Since estimation error may be high, what do some financial economists recommend when using the constant-growth dividend discount model?

Use the industry average rate of return for R

What are the three basic patterns of dividend growth?

Zero growth Differential growth Constant growth

Assuming an inflationary environment, a firm that uses LIFO accounting will have _____ PE ratio than an equivalent firm using FIFO accounting.

a higher

EBITDA measures earnings before ______.

amortization depreciation interest

The price earnings ratio is found by dividing the current price per share by its ______.

earnings per share

The value of a firm is the function of its ______ rate and its _______ rate.

growth; discount

A firm may choose to forgo dividends today if growth opportunities are _____.

high

The ratio of this year's retained earnings to net income is called the ______ ratio.

retention

A net investment of zero occurs when total investment

equals depreciation.

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 percent?

$22.73 Reason: P1= ($5 + 20)/1.10 = $22.73

Earnings next year are a function of which factors?

Earnings this year Retained earnings this year Return on retained earnings

Which of the following is not a reason that some argue preferred stock is debt in disguise?

Preferred shareholders receive no value if a corporation is liquidated.

The value of a firm's common stock to an investor is the ____ value of all the ____ future dividends.

Present Expected

An asset's value is determined by the ____ value of its ____ cash flows.

Present Future

A zero-growth model for stock valuation is distinguished by a ____.

constant dividend amount

In order to prevent voting that freezes out minority shareholders, many states have mandatory ______ voting.

cumulative

An asset's value is determined by the present value of its ______ cash flows.

future

The ______ can be interpreted as the capital gains yield.

growth rate

A firm with growth opportunities should sell for ____ a firm without growth opportunities.

more than

The right of stockholders to share proportionally in any new stock sold is known as the

preemptive right.

Firms seem to hold excessive amounts of cash so cash is ______ enterprise value ratios.

subtracted out of

Which of the following are true of the return on equity?

It is the return on the cumulation of all of the firm's past projects. It is the return on the firm's entire equity. It can be used to estimate the anticipated return on current retained earnings.

The value of a firm is a function of which of the following?

Its growth rate Its discount rate

The PE ratio is negatively related to the ____.

stock's risk firm's discount rate

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

$20.00 Reason: P0 = $2/0.10 = $20

What is the price of a stock at the end of one year (P1) if the dividend for Year 2 (D2) is $6, the price for Year 2 (P2) is $40, and the discount rate is 5 percent?

$43.81 Reason: P1= ($6 + 40)/1.05 = $43.81

The stock of Boyle Industries is selling for $21 per share and its earnings per share is $3.00. What is Boyle's PE ratio?

Reason: PE ratio = $21/$3.00 = 7

Stock sale price and dividends are

kinds of cash flows investing in a stock can provide. included in the valuation of stock.

If a zero-dividend stock is purchased for $80 and sold one year later for $84, the 1-year return is ______ percent.

5 Reason: ($84/$80) - 1 = 5%

The price earnings (PE) ratio is a function of which three factors?

Accounting practices Risk level Growth opportunities

Which of the following is a reason that an investor should pay a higher price for stock in a firm with growth opportunities than a firm without growth opportunities?

The investor is buying both current income and growth opportunities.

Net investment is equal to the total investment minus ____.

depreciation

With straight voting

directors are elected one at a time. you must have 50% plus one vote to guarantee a seat on the board.

Some financial economists suggest using the average R for an entire industry because they argue that

the estimation error for R for a single security is too large to be practical.

Which of the following are true regarding applying present value analysis to stock?

Critics argue that investors are too shortsighted to care about the long-run stream of dividends. Prices in a market dominated by short-term investors will reflect only near-term dividends. The long-run dividend discount model holds because even when investors want to cash out, they have to find a willing buyer.

The determinants of a firm's growth rate include which factors?

Return on retained earnings The retention ratio

When estimating the growth rate, g, with the constant-growth stock valuation model, it is assumed that the ______ ratio stays the same.

retention

The dividend yield is determined by dividing next year's expected cash dividend by the ____.

current stock price

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

zero

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

Dividend/Discount rate

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

Dividends may grow at a constant rate.

What are the effects of staggering the elections for the board of directors?

Decreased likelihood of a successful takeover attempt Increased prevention of minority shareholder control of the board Improved continuity on the board of directors

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

Discount rate Annual dividend amount

When enterprise value is calculated, cash is subtracted from the market value of debt and equity because ____.

an EV ratio should reflect the ability of productive assets to create cash flow many firms hold more cash than necessary

One objection to the present value analysis of stocks is that investors _____.

are shortsighted

Calculating the present value of stock with differential growth dividends requires

calculating the present value of dividends at each growth rate.

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 price of a share of common stock is equal to the present value of the _____ future dividends.

expected

A no-dividend firm can still pay off for an investor by ______.

paying high dividends in the future. being acquired in the future.

Although preferred stock is a form of equity, there are several reasons that it seems like debt. Which of the following are among those reasons preferred stock seems like debt?

If a corporation is liquidated, preferred shareholders get a stated value. Preferred stocks often carry credit ratings.

What are the effects of staggering the elections for the board of directors?

Increased prevention of minority shareholder control of the board Improved continuity on the board of directors Decreased likelihood of a successful takeover attempt

Why do no-payout stocks sell at positive prices?

Investors speculate on capital returns if the firm is sold. Investors count on future dividends.

Which type of growth describes a company that grows quickly at first but then grows slower in later years?

Differential growth

In the dividend growth model, the expected return for investors comes from which two sources?

Growth rate Dividend Yield

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

Sale price Dividends