Int Inv

The set of portfolios formed with the T-bill and security C. Security C has the highest reward-to-volatility ratio.

11.12 Consider a T-bill with a rate of return of 5% and the following risky securities:Security A: E(r) = 0.15; Variance = 0.04Security B: E(r) = 0.10; Variance = 0.0225Security C: E(r) = 0.12; Variance = 0.01Security D: E(r) = 0.13; Variance = 0.0625From which set of portfolios, formed with the T-bill and any one of the four risky securities, would a risk-averse investor always choose his portfolio?

understanding how returns increase relative to risk increases.

11.15 A reward-to-volatility ratio is useful in

III only

11.25 Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities?I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

0.13 Slope = (6 - 3)/23 = 0.1304

11.26 Given an optimal risky portfolio with expected return of 6%, standard deviation of 23%, and a risk free rate of 3%, what is the slope of the best feasible CAL?

dividend-payout ratio

7.7 Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings.

includes capital gains implicitly.

7.8 The dividend discount model

4%. 6% + [-0.25(14% - 6%)] = 4%.

8.21 Fools Gold Mining Company is expected to pay a dividend of $8 in the upcoming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Fools Gold Mining Company has a beta of -0.25. The return you should require on the stock is

dividend-payout ratio

8A10 Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings.

carefully examine inputs to the model and perform sensitivity analysis on price estimates.

7.9 Because the DDM requires multiple estimates, investors should

grow slowly

8A14 Low P/E ratios tend to indicate that a company will _______, ceteris paribus.

They only accept risky investments that offer risk premiums over the risk-free rate.

9.1 Which of the following statements regarding risk-averse investors is true?

E(r) = 0.15; Variance = 0.20 A gives the highest return with the least risk; return per unit of risk is 0.75, which dominates the reward-risk ratio for the other choices.

11.1 According to the mean-variance criterion, which one of the following investments dominates all others?

60% and 40% 0.06 = x(0.15); x = 40% in risky asset.

11.10 You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05.What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.06?

0.4667. (0.12 - 0.05)/0.15 = 0.4667.

11.11 You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05.The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to

0.19; 0.81 E(rp) = 0.6(14%) + 0.4(10%) = 12.4%; 11% = 5x + 12.4(1 - x); x = 0.189 (T-bills) (1-x) = 0.811 (risky asset).

11.13 You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.If you want to form a portfolio with an expected rate of return of 0.11, what percentages of your money must you invest in the T-bill and P, respectively?

$240; $160 $400(0.6) = $240 in X; $400(0.4) = $160 in Y.

11.14 You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.What would be the dollar values of your positions in X and Y, respectively, if you decide to hold 40% of your money in the risky portfolio and 60% in T-bills?

the capital allocation line.

11.16 In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called

10.32% E(rC) = 0.8 × 12.00% + 0.2 × 3.6% = 10.32%

11.17 Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills. The information below refers to these assets. E(Rp) 12.00%Standard Deviation of P 7.20%T-Bill rate 3.60% Proportion of Complete Portfolio in P 80%Proportion of Complete Portfolio in T-Bills 20% Composition of P: Stock A 40.00% Stock B 25.00% Stock C 35.00% Total 100.00% What is the expected return on Bo's complete portfolio?

5.76% Std. Dev. of C = 0.8 × 7.20% = 5.76%.

11.18 Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills. The information below refers to these assets. E(Rp) 12.00%Standard Deviation of P 7.20%T-Bill rate 3.60% Proportion of Complete Portfolio in P 80%Proportion of Complete Portfolio in T-Bills 20% Composition of P: Stock A 40.00% Stock B 25.00% Stock C 35.00% Total 100.00% What is the standard deviation of Bo's complete portfolio?

E(rC) = 3.6 + 1.167 × Standard Deviation of C The intercept is the risk-free rate (3.60%) and the slope is (12.00% - 3.60%)/7.20% = 1.167

11.19 Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills. The information below refers to these assets. E(Rp) 12.00%Standard Deviation of P 7.20%T-Bill rate 3.60% Proportion of Complete Portfolio in P 80%Proportion of Complete Portfolio in T-Bills 20% Composition of P: Stock A 40.00% Stock B 25.00% Stock C 35.00% Total 100.00% What is the equation of Bo's capital allocation line?

E(r) = 0.10; Standard deviation = 0.10 Portfolio A has a reward to risk ratio of 1.0; portfolio C is the only choice with the same risk-return trade-off.

11.2 Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard deviation of 0.15, that lies on a given indifference curve. Which one of the following portfolios might lie on the same indifference curve?

32%, 20%, 28% Proportion in A = 0.8 × 40% = 32%; proportion in B = 0.8 × 25% = 20%; proportion in C = 0.8 × 35% = 28%.

11.20 Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills. The information below refers to these assets. E(Rp) 12.00%Standard Deviation of P 7.20%T-Bill rate 3.60% Proportion of Complete Portfolio in P 80%Proportion of Complete Portfolio in T-Bills 20% Composition of P: Stock A 40.00% Stock B 25.00% Stock C 35.00% Total 100.00% What are the proportions of stocks A, B, and C, respectively, in Bo's complete portfolio?

62.5% and 37.5% 8% = w1(11%) + (1 - w1)(3%); 8% = 11%w1 + 3% - 3%w1; 5% = 8%w1; w1 = 0.625; 1 - w1 = 0.375; 0.625(11%) + 0.375(3%) = 8.0%.

11.21 You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a T-bill with a rate of return of 0.03.What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.08?

0.325. (0.17 - 0.04)/0.40 = 0.325.

11.22 You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a T-bill with a rate of return of 0.04.The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to

the portion of the investment opportunity set that lies above the global minimum variance portfolio.

11.23 The efficient frontier of risky assets is

the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.

11.24 The capital allocation line provided by a risk-free security and N risky securities is

borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities

11.27 An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the capital allocation line must

Only portfolio W cannot lie on the efficient frontier.

11.28 Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz? PortfolioExpected ReturnStandard DeviationW 9% 21%X 5% 7%Y 15% 36%Z 12% 15%

covariance and correlation.

11.29 A statistic that measures how the returns of two risky assets move together is:

Investment B dominates investment C. Investment B dominates investment C because investment B has a higher return and a lower standard deviation (risk) than investment C.

11.3 According to the mean-variance criterion, which of the statements below is correct? Investment E(r)Standard DeviationA 10% 5%B 21% 11%C 18% 23%D 24% 16%

-1.00 The correlation coefficient of -1.00 provides the greatest diversification benefits.

11.30 For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks?

0.033 Cov(rX, rY) = (0.7)(0.18)(0.26) = 0.0327

11.31 Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of 15% and standard deviation of 26%. If the two securities have a correlation coefficient of 0.7, what is their covariance?

portfolio opportunity set.

11.32 The line representing all combinations of portfolio expected returns and standard deviations that can be constructed from two available assets is called the

the assets have a correlation coefficient equal to negative one.

11.33 A two-asset portfolio with a standard deviation of zero can be formed when

investment opportunity set formed with a risky asset and a risk-free asset.

11.4 The capital allocation line can be described as the

0.087; 0.06 E(rP) = 0.3(15%) + 0.7(6%) = 8.7%; sP = 0.3(0.04)1/2 = 6%.

11.5 An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively.

0.081; 0.052 E(rP) = 0.3(13%) + 0.7(6%) = 8.1%; sP = 0.3(0.03)1/2 = 5.19%.

11.6 An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of 0.03 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively.

0.095; 0.113 E(rP) = 0.4(17%) + 0.6(4.5%) = 9.5%; sP = 0.4(0.08)1/2 = 11.31%.

11.7 An investor invests 40% of his wealth in a risky asset with an expected rate of return of 0.17 and a variance of 0.08 and 60% in a T-bill that pays 4.5%. His portfolio's expected return and standard deviation are __________ and __________, respectively.

0.120; 0.14 E(rP) = 0.7(15%) + 0.3(5%) = 12.0%; sP = 0.7(0.04)1/2 = 14%.

11.8 An investor invests 70% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 30% in a T-bill that pays 5%. His portfolio's expected return and standard deviation are __________ and __________, respectively.

57% and 43% 9% = w1(12%) + (1 - w1)(5%); 9% = 12%w1 + 5% - 5%w1; 4% = 7%w1; w1 = 0.57; 1 - w1 = 0.43; 0.57(12%) + 0.43(5%) = 8.99%.

11.9 You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05.What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.09?

50% ($1 + $29 - $20)/$20 = 0.5000, or 50%.

5.1 You purchased a share of stock for $20. One year later, you received $1 as a dividend and sold the share for $29. What was your holding-period return?

14.0% ($3.00 + $74.50 - $68.00)/$68.00 = 0.1397, or 14.0%.

5.2 You purchased a share of stock for $68. One year later, you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return?

the capital gain yield during the period plus the dividend yield

5.3 The holding-period return (HPR) on a share of stock is equal to

5.56% HPR = (92 - 90 + 3)/90 = 5.56%.

5.4 You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return?

the dividend yield plus the capital gains yield.

5.5 The holding-period return (HPR) for a stock is equal to

1.02% HPR = ($15 + 980 - 985)/$985 = 0.010152284 = approximately 1.02%.

5.6 An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding-period return on his investment?

2.45% HPR = ($17 + 987 - 980)/$980 = .0244898 = approximately 2.45%.

5.7 An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987. What is the holding-period return on his investment?

0.57% ($2.37 + $63 - $65)/$65 = 0.00569, or 0.57%.

5.8 You purchased a share of stock for $65. One year later, you received $2.37 as a dividend and sold the share for $63. What was your holding-period return?

None of the options are correct. ($2 + $31 - $20)/$20 = 0.65, or 65%.

5.9 You purchased a share of CSCO stock for $20. One year later, you received $2 as a dividend and sold the share for $31. What was your holding-period return?

Fundamental analysts

7.1 ____ are analysts who use information concerning current and prospective profitability of a firm to assess the firm's fair market value.

intrinsic value

7.2 The _______ is defined as the present value of all cash proceeds to the investor in the stock.

$14.96 .12 = (16 - P + 0.75)/P; .12P = 16 - P + 0.75; 1.12P = 16.75; P = 14.96.

7.3 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return.

$30.23 .10 = (32 - P + 1.25)/P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.

7.4 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.

$26.52 .15 = (28 - P + 2.50)/P; .15P = 28 - P + 2.50; 1.15P = 30.50; P = 26.52.

7.5 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return.

None of the options are correct. .10 = (42 - P + 3.50)/P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.

7.6 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.

is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k.

8.1 The Gordon model

$10.42 1.25/.12 = 10.42.

8.10 A preferred stock will pay a dividend of $1.25 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 12% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

$31.82 3.50/.11 = 31.82.

8.11 A preferred stock will pay a dividend of $3.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 11% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

None of the options are correct. 7.50/.10 = 75.00.

8.12 A preferred stock will pay a dividend of $7.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

$60.00 6.00/.10 = 60.00.

8.13 A preferred stock will pay a dividend of $6.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

$30.23 .10 = (32 - P + 1.25)/P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.

8.14 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.

$14.96 .12 = (16 - P + 0.75)/P; .12P = 16 - P + 0.75; 1.12P = 16.75; P = 14.96.

8.15 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return.

None of the options are correct .10 = (42 - P + 3.50)/P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.

8.16 You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.

7% k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07.

8.17 Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. The beta of Sure Tool Company's stock is 1.25. If Sure's intrinsic value is $21.00 today, what must be its growth rate?

14.6% 5% + 1.2(13% - 5%) = 14.6%.

8.18 Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2.What is the return you should require on Torque's stock?

$11.62 k = 5% + 1.2(13% - 5%) = 14.6%; P = 1/(.146 - .06) = $11.62.

8.19 Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2.What is the intrinsic value of Torque's stock?

will be less than the intrinsic value of stock Y. PV0 = D1/(k - g); given k and g are equal, the stock with the larger dividend will have the higher value.

8.2 You wish to earn a return of 13% on each of two stocks, X and Y. Stock X is expected to pay a dividend of $3 in the upcoming year while stock Y is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock X

30%. 6% + 3(14% - 6%) = 30%.

8.20 Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Midwest Airline has a beta of 3.00. The return you should require on the stock is

$133.33. k = 6% + [-0.25(14% - 6%)] = 4%; P = 8/[.04 - (-.02)] = $133.33.

8.22 Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining Company has a beta of -0.25. The intrinsic value of the stock is

$46.67. 6% + 3(14% - 6%) = 30%; P = 7/(.30 - .15) = $46.67.

8.23 Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Low Fly Airline has a beta of 3.00. The intrinsic value of the stock is

$25.00. 6% + 0.75(14% - 6%) = 12%; P = 1.50/(.12 - .06) = $25.

8.24 Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is

$71.80 P3 = $2.54 (1.08)/(.11 - .08) = $91.44; PV of P3 = $91.44/(1.11)3 = $66.86; P0 = $4.94 + $66.86 = $71.80.

8.25 JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today.

$40.68 P3 = 2 (1.10)/(.14-.10) = $55.00; PV of P3 = $55/(1.14)3 = $37.12; P0 = $3.56 + $37.12 = $40.68.

8.26 Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _______ today.

$10.57. P3 = 1.00 (.99)/[.10 - (-.01)] = $9.00; PV of P3 = $9/(1.10)3 = $6.7618; P0 = $6.7618 + $3.8092 = $10.57.

8.27 Mature Products Corporation produces goods that are very mature in their product life cycles. Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a dividend of $1.50 in year 2, and a dividend of $1.00 in year 3. After year 3, dividends are expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth

$28.57. P1 = 2 (1.05)/(.12 - .05) = $30.00; PV of P1 = $30/1.12 = $26.78; PV of D1 = 2/1.12 = 1.79; PO = $26.78 + $1.79 = $28.57.

8.28 Assume that Bolton Company will pay a $2.00 dividend per share next year, an increase from the current dividend of $1.50 per share that was just paid. After that, the dividend is expected to increase at a constant rate of 5%. If you require a 12% return on the stock, the value of the stock is

$39.71 P5 = 3.7164/(.11 - .03) = $46.4544; PV of P5 = $46.4544/(1.11)5 = $27.5684; PO = $12.1449 + $27.5684 = $39.71.

8.29 The growth in dividends of Music Doctors, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years. After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were $2.75. What should the stock sell for today?

will be less than the intrinsic value of stock D. PV0 = D1/(k - g); given k and g are equal, the stock with the larger dividend will have the higher value.

8.3 You wish to earn a return of 11% on each of two stocks, C and D. Stock C is expected to pay a dividend of $3 in the upcoming year while stock D is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock C

$25.21 P5 = 2.80 (1.02)/(.12 - .02) = $28.56; PV of P5 = $28.56/(1.12)5 = $16.21; PO = $16.20 + $8.99 = $25.21.

8.30 The growth in dividends of XYZ, Inc. is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years. After this five-year period, the growth in dividends is expected to be 2% per year, indefinitely. The required rate of return on XYZ, Inc. is 12%. Last year's dividends per share were $2.00. What should the stock sell for today?

includes capital gains implicitly

8.31 The dividend discount model

will be less than the intrinsic value of stock B. PV0 = D1/(k - g); given that dividends are equal, the stock with the higher growth rate will have the higher value.

8.4 You wish to earn a return of 12% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A

will be less than the intrinsic value of stock D. PV0 = D1/(k - g); given that dividends are equal, the stock with the higher growth rate will have the higher value.

8.5 You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C

will be greater than the intrinsic value of stock B. PV0 = D1/(k - g); given that dividends are equal, the stock with the larger required return will have the lower value.

8.6 Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year. The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A

will be greater than the intrinsic value of stock D. PV0 = D1/(k - g); given that dividends are equal, the stock with the larger required return will have the lower value.

8.7 Each of two stocks, C and D, are expected to pay a dividend of $3 in the upcoming year. The expected growth rate of dividends is 9% for both stocks. You require a rate of return of 10% on stock C and a return of 13% on stock D. The intrinsic value of stock C

$27.50 2.75/.10 = 27.50.

8.8 A preferred stock will pay a dividend of $2.75 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

$33.33 3.00/.09 = 33.33.

8.9 A preferred stock will pay a dividend of $3.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

6.0% 10% × 0.60 = 6.0%.

8A1 Low Tech Company has an expected ROE of 10%. The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends.

5.6%. 14% × 0.40 = 5.6%.

8A11 A firm has a return on equity of 14% and a dividend-payout ratio of 60%. The firm's anticipated growth rate is

$17.67. g = 10% × 0.6 = 6%; P = 1 (1.06)/(.12 - .06) = $17.67.

8A12 Sales Company paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future. If the firm is expected to generate a 10% return on equity in the future, and if you require a 12% return on the stock, the value of the stock is

fundamental analysts

8A13 Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities.

5.6% 14% × 0.40 = 5.6%.

8A2 Music Doctors Company has an expected ROE of 14%. The dividend growth rate will be ________ if the firm follows a policy of paying 60% of earnings in the form of dividends.

4.8% 16% × 0.30 = 4.8%.

8A3 Medtronic Company has an expected ROE of 16%. The dividend growth rate will be ________ if the firm follows a policy of paying 70% of earnings in the form of dividends.

8.25% 11% × 0.75 = 8.25%.

8A4 Light Construction Machinery Company has an expected ROE of 11%. The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.

0.9% 9% × 0.10 = 0.9%.

8A5 Bubba Gumm Company has an expected ROE of 9%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 10% of earnings.

$27.50 2.75/.10 = 27.50.

8A6 A preferred stock will pay a dividend of $2.75 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

$93.50. 17 × $5.50 = $93.50.

8A7 Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to have an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be

$0.80. $20(1/25) = $0.80.

8A8 An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is

$38.46. g = 14% × 0.6 = 8.4%; Expected DPS = $2.50(0.4) = $1.00; P = 1/(.11 - .084) = $38.46.

8A9 Low Tech Chip Company is expected to have EPS of $2.50 in the coming year. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be

I and II only

9.2 Which of the following statements is(are) true?I) Risk-averse investors reject investments that are fair games.II) Risk-neutral investors judge risky investments only by the expected returns.III) Risk-averse investors judge investments only by their riskiness.IV) Risk-loving investors will not engage in fair games.

III and IV only

9.3 Which of the following statements is(are) false?I) Risk-averse investors reject investments that are fair games.II) Risk-neutral investors judge risky investments only by the expected returns.III) Risk-averse investors judge investments only by their riskiness.IV) Risk-loving investors will not engage in fair games.

for the same return, David tolerates higher risk than Elias.

9.4 Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore,