Chapter 8 - STOCK EVALUATION

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

growth; discount

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

the current price (P0)

The constant growth formula calculates the stock price:

one year prior (year t) to the first dividend payment (Dt +1)

constant growth model required return formula

rs= D1/P0 + g

When a company is new and does not pay dividends and is not yet profitable, then you may use a benchmark price- _____ ratio to estimate the stock price.

sales

Three special case patterns of dividend growth include _____.

zero growth constant growth nonconstant growth

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

future

Dividends formula

Dn= D0(1+g)^n+1

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

False

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

constant dividend amount

The value of a share of common stock in a corporation is _____ to the general rights of shareholders.

directly related

the value of a share of common stock in a corporation is _____ to the general rights of shareholders.

directly related

Is a company required to pay preferred dividends?

No; the company may defer dividends on preferred stock; however they can not pay dividends to common shareholders until preferred dividends are paid.

Which is the formula used to estimate a stock price based on the benchmark PE?

Pt = Benchmark PE ratio × EPSt

Which of the following entities declares a dividend?

The board of directors

A ____ is the grant of authority by a shareholder to someone else to vote his or her shares.

proxy

In which way(s) is preferred stock like a bond?

--Preferred shareholders receive a stated value if the firm liquidates, like bondholders. --Some preferred stock has credit ratings, like bonds. --Preferred shareholders receive a stated dividend, similar to interest on a bond. --Preferred stock sometimes has a sinking fund, giving it a set maturity like bonds.

Preferred shares have a stated liquidating value, typically $_____ per share.

100

A share of common stock can be valued by determining the ______ value of its future cash flows.

present

When assuming non-constant growth in dividends, to avoid the problem of having to forecast and discount an infinite number of dividends, we must require that the dividends _____.

start growing at a constant rate sometime in the future

In a directors ____ board, only a fraction of the directorships are up for election at any one time.

staggered or classified

Shareholders typically have the right to share proportionally in ______ paid.

dividends

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

zero

Most voting in large corporations is done by proxy because _____.

most small shareholders do not attend the annual meeting Reason: Large corporations often have hundreds, thousands, or even millions of shareholders. For small shareholders, it is more convenient for them to assign someone else to vote their shares. Management cannot prohibit any shareholders from attending the annual meeting.

When applying two-stage growth, in the second stage, g2 _____.

must be less than R

A stock with dividend priority over common stock is called a Blank______ stock.

preferred

Preferred stock has preference over common stock in the _____.

distribution of corporate assets payment of dividends

The dividend growth model determines the current price of a stock as its dividend next period ________ (multiplied/divided) by the discount rate _______ (less/plus) the dividend growth rate.

divided, less

When the stock being valued does not pay dividends,

the dividend growth model can still be used. Reason: The dividend growth model can still be used. The analyst must assume that, at some point in the company's future, it begins paying dividends. (Though this assumption can be considered far-fetched, the process is still valid if the assumption is made. Therefore, the model can be used and the answer is "true.")

What is the formula to determine the price of a stock at the end of one year (P1) if the dividend for Year 2 (Div2) is $5, the price for Year 2 (P2) is $20, and the discount rate is 10 percent?

P1 = ($5 + 20)/1.10

Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?

The life of a common stock is essentially forever. The rate of return required by the market is not easily observed. Common stock cash flows are not known in advance

Which of the following is usually a right of common shareholders?

The right to a proportional share of dividends paid and voting rights

True or false: It can be advantageous to have a staggered board because it provides "institutional memory."

True

True or false: With more than one class of common stock, it is easier for insiders such as founding families to maintain control of the company.

True

One requirement of the dividend growth model is _____.

g < R Reason: For the dividend growth model to be useful, the long-term growth rate must be smaller than the discount rate.

Target stock price in one year

next year's EPS x benchmark PE

When voting for the board of directors, the number of votes a shareholder is entitled to is usually _____ vote per share held.

one

Constant growth rate formula

P0=D1/(R-g)

The main reason for considering nonconstant growth in dividends is to allow for _____ growth rates over _____.

supernormal; some finite length of time

With ______ voting, the directors are elected one at a time and the only way to guarantee a seat is to own 50 percent plus one share.

straight

Using the dividend growth model requires that the growth rate be _____ the discount rate.

smaller than

Mota Motors has eight directors on its board, two of whom go up for election each year. This is an example of a:

staggered board

The goal of many successful organizations is a(n) ______ rate of growth in dividends.

steady

Suppose Bob owns 20 shares and Vikki owns 30 shares in Good Company, and there are five members of the board of directors. Under which voting arrangement can Bob assure himself of a board member that represents his interests?

Cumulative voting Reason: Under cumulative voting, Bob would have 20 X 5 = 100 votes to cast. He could cast all 100 shares for a candidate of his choice, assuring the candidate of a seat on the board. Vikki would have a total of 30 X 5 = 150 shares, and there is no way to distribute her shares over five candidates such that each had more than 100 votes.

WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?

No minority shareholder would have enough votes to win any seat on the board.

A _____ is a payment by a corporation to shareholders, made in either cash or stock

dividend

Five Star Corporation will pay a dividend of $3.04 per share next year. The company pledges to increase its dividend by 3.75 percent per year indefinitely. If you require a return of 11 percent on your investment, how much will you pay for the company's stock today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

$41.93

Dusty Corporation has an issue of preferred stock that pays a dividend of 7 percent of its state value, which is $100. Which of the following would be a commonly used name for that preferred stock?

$7 preferred Reason: The preferred stock would often be called by its dividend amount, so it would be called "$7 preferred."

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

Fegley, Incorporated, has an issue of preferred stock outstanding that pays a $3.80 dividend every year in perpetuity. If this issue currently sells for $93 per share, what is the required return? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

4.09%

Caccamise Company is expected to maintain a constant 3.4 percent growth rate in its dividends indefinitely. If the company has a dividend yield of 5.3 percent, what is the required return on the company's stock? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

8.70%

Match the following terms relating to stock valuation:

P1 --- Price in one year D1 ---Dividend in one year R ---Discount rate P0 --- Price today

What is the formula to determine the price of a stock at the end of one year (P1) if the dividend for Year 2 (Div2) is $10, the price for Year 2 (P2) is $15, and the discount rate is 8 percent?

P1 = ($10 + 15)/1.08

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

R = ($2/$100) + .08

he RLX Company just paid a dividend of $3.20 per share on its stock. The dividends are expected to grow at a constant rate of 4 percent per year indefinitely. Investors require a return of 10.5 percent on the company's stock. a.What is the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b.What will the stock price be in 3 years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c.What will the stock price be in 15 years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

a. $51.20 b.$57.59 c. $92.21

The ______ can be interpreted as the capital gains yield.

constant growth rate

If preferred dividends are _____ and are not paid in a given year, they will be carried forward as an arrearage.

cumulative

preferred stock required return formula, dividend yield

dividend/ required return

Preferred shareholders receive a stated value if the firm liquidates, _______ (like/unlike) bondholders.

like

A share of common stock is ______ (less/more) difficult to value in practice than a bond.

more

If a zero-dividend stock is purchased for $80 and sold one year later for $84, the 1-year return can be found using the formula ______.

($84/$80) − 1

Implicit return on stock

(target stock price for next year - current stock price)/current stock price shows as percent.

The next dividend payment by Im, Incorporated, will be $1.87 per share. The dividends are anticipated to maintain a growth rate of 4.3 percent forever. If the stock currently sells for $37 per share, what is the required return? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

9.35% or .0935

Matthews Company has two classes of common stock, and each share represents the same proportion of ownership in the company. Class A has 2 votes for each share. Class B has one vote per share. Which class is more valuable?

Class A Reason: Larger voting rights add value to the Class A shares.

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

Discount rate Annual dividend amount

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

Dividend Yield Growth rate

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

Dividends Capital gains

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

Dividends may grow at a constant rate.

Price in x years:

Dn/(R-g)

Next year's earnings-per-share (EPS)

EPS(1+earnings growth rate)

A benchmark PE ratio can be determined using:

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

Meadow Dew Corporation currently has an EPS of $4.05, and the benchmark PE for the company is 21. Earnings are expected to grow at 4.9 percent per year. a.What is your estimate of the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b.What is the target stock price in one year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c. Assuming the company pays no dividends, what is the implied return on the company's stock over the next year? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

a. current stock price: $85.05 b. target stock price in one year 4.24845 x 21 = 89.22 c. implied return on stock 4.90%

current stock price

benchmark PE x earnings-per-share (EPS)

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

decreases

The idea for ____ -stage growth is that the dividend will grow at a rate of g1 for t years and then grow at a rate of g2 thereafter, forever.

two

True or false: Cumulative voting means board members are elected one at a time, with each shareholder casting his or her allotted votes for each seat on the board.

False Reason: Cumulative voting means that each shareholder may distribute votes however he or she wishes. If there are four seats on the board and the shareholder owns 20 shares, he or she can cast 80 votes for one board member.

Which of the following are features of common stock?

It generally has voting rights. It has no special preference in bankruptcy. It has no special preference in receiving dividends.

The assumption of constant growth infers that _________.

dividends change at a constant rate

One common reason for having two classes of common stock with different voting rights is _____.

it is easier for insiders such as founding families to maintain control of the company

One reason corporations use staggered boards is that _____.

it makes takeover attempts less likely to be successful

If the implicit return is the same as the growth rate in earnings

Assuming a stock pays no dividend and the PE ratio is constant, this will ALWAYS be true when using price ratios to evaluate the price of a share of stock.

The price of a share of common stock is equal to the present value of all expected future

dividends