CH 7 FIN3403

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 Rylan's equity cost of capital is 12%, what price would you expect Rylan's stock to sell for at the end of the four years? a)$21.96 b)$39.53 c)$17.57 d)$61.49

a)$21.96 PV=-31.27 PMT=5.7 N=4 i/y=12 CPT FV=21.96

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 Coolibah's equity cost of capital is 18%, what price would you expect Coolibah's stock to sell for at the end of three years? a)$28.87 b)$31.76 c)$33.20 d)$34.64

a)$28.87 PV=-22.6 PMT=1.2 N=6 i/y=9% CPT FV=28.87

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? a)$3.56 b)$56.88 c)$5.12 d)$58.44

a)$3.56 P0 using the capital gain rate formula=(1.7+62)/(1+0.09)=$58.44 Capital gain=P1-P0=62-58.44 =3.56

Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBC's dividend to grow by 6% per year forever and VBC's equity cost of capital to be 13%, then the value of a share of VBC stock is closest to ________. a)$42.86 b)$15.79 c)$25.72 d)$17.14

a)$42.86 P0=Div1/(rE-g) =3/(0.13-0.06)= $42.86

Kirkevue Industries pays out all its earnings as dividends, currently expects earnings to be constant 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? a)1.48% b)0.14% c)0.17% d)0.15%

a)1.48% rE1=2.15/27= 7.96296296% rE2=1.75/27= 6.481481481% growth rate= 7.962%-6.481%= 1.48%

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industries' dividends are expected to grow at a constant rate indefinitely. The growth rate of Luther's dividends is closest to ________. a)5.5% b)14.5% c)11.0% d)5.0%

a)5.5% rE=Div1/P0 +g 0.1=0.045+g so g=5.5%

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 firm's 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.

b) total return equals earnings multiplied by the dividend payout rate

NoGrowth Industries presently pays an annual dividend of $1.20 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 10%, then the value of a share of NoGrowth's stock is closest to ________. a)$9.60 b)$14.40 c)$13.20 d)$12.00

d)$12.00 P0=Div1/(rE-g) =1.2/(0.1-0)=$12

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? a)$12.71 b)$14.83 c)$16.94 d)$21.18

d)$21.18 D1=2x(1-0.1)= 1.8 g=0.1x0.25= 0.025 P0=1.8/(0.11-0.025)=$21.18

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 firm's future dividends states that they will grow at a constant rate, i.e., forever.

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

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? a)$20.62 b)$24.17 c)$33.96 d)$33.51

b)$24.17 E4=$3.16932 D4=$2.37699 P3=2.37699/(0.12-0.05)=$33.96 P0=33.96/(1+0.12)^3= $24.17

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firm's 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 Aaron's earnings are expected to grow at a constant 7% per year, what is Aaron's share price? a)$12.48 b)$24.96 c)$37.44 d)$49.92

b)$24.96 P0=(0.5x$641mil)/(0.11-0.07)=$8012.5mil Price per share=$8012.5mil/321mil=$24.96

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 Gremlin's stock is $23.50 per share. What is Gremlin's equity cost of capital? a)11% b)12% c)14% d)16%

b)12% Cost of capital=(1.9/23.5) + 0.04 =12%

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. KTI's return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTI's dividends is closest to ________. a)11.3% b)9.8% c)5.9% d)3.9%

b)9.8% g=retention rate x return on new investment =(5-1.25)/5 x0.13 =0.0975 or 9.8%

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

b)PN=(rE-g) x DivN+1 PN=DivN+1/(rE-g)

You expect KT industries (KTI) will have earnings per share of $4 this year and expect that they will pay out $1.75 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 13% and their equity cost of capital is 10%. The value of a share of KTI's stock today is closest to ________. a)$78.14 b)$39.07 c)$65.12 d)$26.05

c)$65.12 g=retention rate x return on new investment =(4-1.75)/4 x0.13 =0.073125 or 7.3125% P0=Div1/(rE-g)= 1.75/(0.1-0.073125)=$65.12

The Phelps Company's 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 Phelps Company's equity cost of capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Phelps Company's earnings is closest to ________. a)-1.96% b)-1.47% c)-0.98% d)-0.49%

c)-0.98% P0=Div1/(rE-g) 25.50=2.8/(0.1-g) so g=-00098 or -0.98%

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 firm's earnings per share (EPS) multiplied by its dividend payout rate. c)There is a tremendous amount of uncertainty associated with any forecast of a firm's 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.

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 During periods of high growth, it is not unusual for these firms to retain 100% of their earnings to exploit profitable investment opportunities

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 Sultan's earnings are expected to grow by 5% per year, these payout rates do not change, and Sultan's equity cost of capital is 10%, what is Sultan's share price? a)$12.00 b)$24.00 c)$36.00 d)$60.00

d)$60.00 P0=(0.6x6Mil)/(0.1-0.05)=$72Mil P0=$72Mil/1.2Mil=$60.00

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? a)14% b)13% c)12% d)15%

d)15% 29.5+0.59-26.1 =3.99; 3.99/26.1=15.29% rounded to 15%

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)13.91% d)17.39%

d)17.39% Capital gain rate= (P1-P0)/P0= (27-23)/23=17.39%

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.

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 growth rate 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.