Finance 3716 Chapter 7 Q&A

$7.47

Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firmʹs equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittendenʹs earnings are expected to grow at a constant 3% per year, what is Chittendenʹs share price? A) $3.74 B) $2.24 C) $7.47 D) $14.94

100

A "round lot" consists of how many shares? A) 1 B) 10 C) 100 D) 1,000

0.98% Growth rate= .07- (2.5/41.5)= ___

A company has stock which costs $41.50 per share and pays a dividend of $2.50 per share this year. The companyʹs cost of equity is 7%. What is the expected annual growth rate of the companyʹs dividends? A) 0.98% B) 1.96% C) 2.94% D) 3.92%

True

A firm can either pay its earnings to its investors, or it can keep them and reinvest them.

False floor broker is a person at the NYSE

A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.

17.39 % Capital gain rate= (P1-P0)/P0=

A stock is bought for $23.00 and sold for $27.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction? A) 3.48% B) 8.70% C) 17.39 %

$8.86 P0= .7/.079= ___

A stock is expected to pay $0.70 per share every year indefinitely. If the current price of the stock is $18.90 , and the equity cost of capital for the company that released the shares is 7.9%, what price would an investor be expected to pay per share five years into the future? A) $8.86 B) $14.18 C) $14.62

$14.88 P0= 1.25/.084= ___

A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the company is 8.4%. What price would an investor be expected to pay per share ten years in the future? A) $14.88 B) $22.32 C) $29.76 D) $37.20

$24.96

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected to grow at a constant 7% per year, what is Aaronʹs share price? A) $12.48 B) $24.96 C) $37.44 D) $49.92

P0= 1.2/(.16-.03)= $9.23

Avril Synchronistics will pay a dividend of $1.20 per share this year. It is expected that this dividend will grow by 3% each year in the future. What will be the current value of a single share of Avril's stock if the firm's equity cost of capital is 16%?

$28.87 PV= -22.60; PMT= 1.20; N= 6; I= 18%/2; CPT FV

Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If the current price of Coolibah stock is $22.60 , and Coolibahʹs equity cost of capital is 18%, what price would you expect Coolibahʹs stock to sell for at the end of three years?

$3.56 find P0 = (1.70+62)/(1+.09)= $58.44; Capital gain= P1 - P0= 62-58.44= ___

Credenza Industries is expected to pay a dividend of $1.70 at the end of the coming year. It is expected to sell for $62 at the end of the year. If its equity cost of capital is 9%, what is the expected *capital gain* from the sale of this stock at the end of the coming year?

True

Forecasting dividends requires forecasting the firmʹs earnings, dividend payout rate, and future share count.

12% Cost of capital= (1.9/23.5) + .04= ___

Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that this dividend will grow by 4% per year each year in the future. The current price of Gremlinʹs stock is $23.50 per share. What is Gremlinʹs equity cost of capital? A) 11% B) 12% C) 14%

$19.32 Step 1: solve for rE: rE= Div1/P0+g= Step 2: solve for new stock price: P0= Div1/ (rE-g)=

JRN Enterprises just announced that it plans to cut its dividend from $3.00 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow indefinitely at 4% per year and JRNʹs stock was trading at $25.50 per share. With the new expansion, JRNʹs dividends are expected to grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share of JRN after the announcement is $________.

$21.18 D1= 2x (1-.1)= $1.8; g=.1x.25= .025; P0= .8/(.11-.025)= $____

Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport?

14.33% .28+3.15-3= $.43; COC= .43/3= ___

Jumbuck Exploration has a current stock price of $3.00 and is expected to sell for $3.15 in one yearʹs time, immediately after it pays a dividend of $0.28 . Which of the following is closest to Jumbuck Explorationʹs equity cost of capital? A) 7.17% B) 8.60% C) 14.33% D) 17.91 %

1.48% rE1= 2.15/27= 7.96296296% rE2= 1.75/27= 6.48148148%; Growth rate= rE1 - rE2= ___

Kirkevue Industries pays out all its earnings as dividends and has a share price of $27 . In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged?

5.5% Re= Div1/P0 + g .1= .045 + g; solve for g

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industriesʹ dividends are expected to grow at a constant rate indefinitely. The growth rate of Lutherʹs dividends is closest to ________. A) 5.5% B) 11.0% C) 5.0%

$23.33 PV0=2.10/.09= ___

Matilda Industries pays a dividend of $2.10 per share and is expected to pay this amount indefinitely. If Matildaʹs equity cost of capital is 9%, which of the following would be closest to Matildaʹs stock price?

$12.00 P0= Div1/(rE - g)= = 1.20/(.1-0)= ___

NoGrowth Industries presently pays an annual dividend of $1.20 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowthʹs equity cost of capital is 10%, then the value of a share of NoGrowthʹs stock is closest to ________. A) $9.60 B) $14.40 C) $12.00

$16.00 (1+.12) x $15= $16.80; $16.80-.80= ___

Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owenʹs equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend? A) $12.80 B) $16.80 C) $16.00

$21.96 PV= -31.27; PMT= 5.70; n=4; I=12; CPT FV= ___

Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27 , and Rylanʹs equity cost of capital is 12 %, what price would you expect Rylanʹs stock to sell for at the end of the four years? A) $21.96 B) $39.53 C) $17.57

$25.78 E3= 3.0184; D3= 2.2638; E4= 3.16932; D4= 2.37699; P3= 2.37699/(.12-.05)= $33.96; P0= ($33.96 + 2.2638)/ (1+.12)^3= ___

Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years. After this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today?

False

Stocks that do not pay a dividend must have a value of $0.

$60.00

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultanʹs earnings are expected to grow by 5% per year, these payout rates do not change, and Sultanʹs equity cost of capital is 10%, what is Sultanʹs share price? A) $12.00 B) $24.00 C) $36.00 D) $60.00

$52.38 COC= 3/37= .08108108; g= .33 x .13= .0429; P0= 2/(.08108108 - .0429)= ___

Sunnyfax Publishing pays out all its earnings and has a share price of $37 . In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 13%. If the reinvestment does not affect Sunnyfaxʹs equity cost of capital, what is the expected share price as a consequence of this decision?

15% 29.5+.59-26.10= 3.99; 3.99/26.10= 15.29% round down

The Busby Corporation had a share price at the start of the year of $26.10 , paid a dividend of $0.59 at the end of the year, and had a share price of $29.50 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period?

-0.98% P0= Div1/(rE-g)= 25.5=2.8/(.1-g)

The Sisyphean Companyʹs common stock is currently trading for $25.50 per share. The stock is expected to pay a $2.80 dividend at the end of the year and the Sisyphean Companyʹs equity cost of capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Sisyphean Companyʹs earnings is closest to ________. A) -1.96% B) -1.47% C) -0.98%

true

The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments.

$75.12

Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of $800 million. Valence pays out 40% of its earnings in total15% paid out as dividends and 25% used to repurchase shares. If Valenceʹs earnings are expected to grow by 7% per year, these payout rates do not change, and Valenceʹs equity cost of capital is 9%, what is Valenceʹs share price? A) $11.27 B) $22.54 C) $60.10 D) $75.12

$38.09 CF0=0; CF1= 1.75; CF2= (41+2.35)= 43.35 Calculate NPV at I=9%, =___

Valorous Corporation will pay a dividend of $1.75 per share at this yearʹs end and a dividend of $2.35 per share at the end of next year. It is expected that the price of Valorousʹ stock will be $41 per share after two years. If Valorous has an equity cost of capital of 9%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today?

$42.86 P0= Div1/(rE-g)=

Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBCʹs dividend to grow by 6% per year forever and VBCʹs equity cost of capital to be 13%, then the value of a share of VBS stock is closest to ________. A) $42.86 B) $15.79 C) $25.72

C) a share of the profits paid to each shareholder on the basis of the number of shares they hold

What are dividend payments? A) payments made to a company by investors for a share of the ownership of that company B) the difference between the original cost price of a share and the price an investor receives when that share is sold C) a share of the profits paid to each shareholder on the basis of the number of shares they hold

Answer: It is assumed that the growth rate used in the dividend-discount model be constant in the future.

What is a major assumption about growth rate in the dividend-discount model?

Answer: For the dividend-discount model equation to be viable, the growth rate should be smaller than the cost of equity because the model becomes meaningless if the growth rate is equal to or greater than the cost of equity.

What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?

Answer: Dividends are periodic payments given out by the firm to shareholders. It is not necessary for a firm to declare dividends, but mature firms tend to pay out dividends.

What role do dividends play in stock investing?

D) rE = (Div1 / P0) - g Explanation: should be + g

Which of the following formulas is INCORRECT? A) g = Retention Rate × Return on New Investment B) Divt = EPSt × Dividend Payout Rate C) P0=Div1/(rE-g) D) rE = (Div1 / P0) - g

B) PN = (rE - g) × DivN+1 Explanation: PN= (DivN + 1)/(rE - g)

Which of the following formulas is INCORRECT? A) Divt = EPSt × Dividend Payout Rate B) PN = (rE - g) × DivN+1 C) earnings growth rate = retention rate × return on new investment D) rE = (Divt / P0) + g

A) by increasing its retention rate a firm CAN increase its dividends by: by decreasing its shares outstanding, by increasing its earnings (net income) and its dividend payout rate

Which of the following is NOT a way that a firm can increase its dividend? A) by increasing its retention rate B) by decreasing its shares outstanding C) by increasing its earnings (net income) D) by increasing its dividend payout rate

It cannot handle negative growth rates

Which of the following is a limitation of the dividend-discount model? A) It cannot handle negative growth rates. B) It requires accurate dividend forecasts, which is not possible. C) It requires that the growth rate always be higher than the required rate of return, which is not realistic. D) It does not consider past earnings and performance.

II only

Which of the following models directly values all of the firmʹs equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discounted cash flow model A) I only B) II only C) III only D) II and III

D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends. Explanation: During periods of high growth, it is not unusual for these firms to retain 100% of their earnings to exploit profitable investment opportunities.

Which of the following statements is FALSE about dividend payout and growth? A) A common approximation is to assume that in the long run, dividends will grow at a constant rate. B) The dividend each year is the firmʹs earnings per share (EPS) multiplied by its dividend payout rate. C) There is a tremendous amount of uncertainty associated with any forecast of a firmʹs future dividends. D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.

A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth Explanation: A multistage dividend-discount model can be used to value the stock of a firm with rapid or changing growth.

Which of the following statements is FALSE of the dividend-discount model? A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth. B) As firms mature, their growth slows to rates more typical of established companies. C) The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders. D) The simplest forecast for the firmʹs future dividends states that they will grow at a constant rate, i.e., forever.

A)false: If a firm wants to increase its share price, it must diversify.

Which of the following statements is FALSE regarding profitable and unprofitable growth? A) If a firm wants to increase its share price, it must diversify. B) If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends. C) A firm can increase its growth rate by retaining more of its earnings. D) Cutting a firmʹs dividend to increase investment will raise the stock price if the new investment has a positive net present value (NPV).

B) Total return equals earnings multiplied by the dividend payout rate.

Which of the following statements is FALSE? A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends. B) Total return equals earnings multiplied by the dividend payout rate. C) Cutting the firmʹs dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

D) TRUE: According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital *adjusted by the growth rate.*

Which of the following statements is FALSE? A) Estimating dividends, especially for the distant future, is difficult. B) A firm can only pay out its earnings to investors or reinvest their earnings. C) Successful young firms often have high initial earnings growth rates. D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

A) It can issue more shares

Which of the following will NOT increase a companyʹs dividend payments? A) It can issue more shares. B) It can increase its earnings. C) It can decrease the number of shares outstanding. D) It can increase its dividend payout rate.

I and II

Which of the following will be a source of *cash flows* for a shareholder of a certain stock? I. Sale of the shares at a future date II. The firm in which the shares are held paying out cash to shareholders in the form of dividends III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split A) I only B) II only C) I and II D) II and III

9.8% g= Retention rate x Return on new investment = (5-1.25)/(5x.13)=

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $1.25 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTIʹs dividends is closest to ________. A) 11.3% B) 9.8% C) 5.9% D) 3.9%

$62.50 g= Retention rate x Return on new investment = (5-2.50)/(5x.14)= .07 P0= Div1/ (rE-g)= 2.50/(.11-.07)= ___

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $2.50 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 14% and their equity cost of capital is 11%. The value of a share of KTIʹs stock today is closest to ________. A) $75.00 B) $37.50 C) $62.50

$41.36 P0= 1.73/(1+.1)^4 + 1.9/(1+.1)^5 + (3.14/(10%-5%)) x (1/(1+11%)^5)= $41.36 each g is calculated as the 20% return on the projects x the retention ratio.

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 10%, then the price of a share of Beanʹs stock is $________.

limit order

You placed an order to purchase stock where you specified the maximum price you were willing to pay. This type of order is known as a ________. A) maximum order B) limit order C) market order