Finance Exam #3

Lamey Gardens has a dividend growth rate of 5.6 percent, a market price of $13.16 a share, and a required return of 14 percent. What is the amount of the last dividend this company paid?

$13.16 = (D0 × 1.056) / (.14 − .056)

KIT Kars stock currently sells for $54.10 per share and has a fixed 2.5 percent dividend growth rate. What was the amount of the last dividend paid if the required rate of return is 11 percent?

11% = {[D0 × (1 + .025)] / $54.10} + .025 D0 = $4.49

Trident Office is considering remodeling the office building it leases to Robert Roberts, CPA. The remodeling costs are estimated at $225,000. If the building is remodeled, Robert Roberts, CPA has agreed to pay an additional $75,000 per year in rent for the next five years. The discount rate is 10 percent. What is the benefit of the remodeling project to Professional Properties?

5 10 75,000 0 N I/Y PV PMT FV NPV = −$225,000 + $284,309 = $59,309.01

Juniper Trees has earnings per share of $1.38, all of which is added to retained earnings. What is the value of a share of its stock if the PE ratio is 9.8 and market-to-book ratio is 2.5? A) $13.52 B) $13.67 C) $15.30 D) $33.80 E) $34.18

A) $13.52 Explanation: P = 9.8 × $1.38 = $13.52

Gamma Corp. is expected to pay the following dividends over the next four years: $7.50, $8.25, $15, and $1.80. Afterward, the company pledges to maintain a constant 4 percent growth rate in dividends, forever. If the required return is 14 percent, what is the current share price? A) $35.20 B) $31.06 C) $38.18 D) $32.30 E) $34.90

A) $35.20 P4 = ($1.80 × 1.04) / (.14 − .04) = $18.72 P0 = ($7.50/1.14) + ($8.25/1.142) + ($15/1.143) + [($1.80 + 18.72)/1.144] = $35.20

On 1/29/2019, Apple declared a $0.73-per-share quarterly dividend payable 2/14 to stockholders of record on 2/11. The ex-dividend date is 2/8, Friday. What was the latest date by which you could purchase the stock and still get the recently declared dividend? A) Feb 7 B) Feb 8 C) Feb 10 D) Feb 11 E) Feb 14

A) Feb 7

Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? A) Mutually exclusive B) Conventional C) Multiple choice D) Dual return E) Crosswise

A) Mutually exclusive

Which one of the following statements is correct? A) Preferred shareholders receive preferential treatment over common shareholders in a liquidation. B) Preferred stock generally has a stated liquidation value of $1,000 per share. C) Dividend payments to preferred shareholders are tax-deductible expenses for the issuing firm. D) Preferred dividends are generally variable in amount.

A) Preferred shareholders receive preferential treatment over common shareholders in a liquidation.

An investment has an average book value of $180,000 and a life of four years. It will generate the net income shown below. Should this project be accepted based on the average accounting rate of return (AAR) if the required rate is 9.5 percent? Why or why not? Year Net Income 1 $14,500 2 16,900 3 19,600 4 23,700

Average net income = ($14,500 + 16,900 + 19,600 + 23,700) / 4 = $18,675 AAR = $18,675 / $180,000 = .1038, or 10.38 percent. Yes, because the AAR is greater than 9.5 percent

River City Recycling just paid its annual dividend of $1.15 per share. The required return is 12.3 percent and the dividend growth rate is 0.75 percent. What is the expected value of this stock five years from now? A) $10.16 B) $10.41 C) $12.03 D) $8.42 E) $9.75

B) $10.41 Explanation: P5 = [$1.15 × (1 + .0075)6] / (.123 − .0075) = $10.41

Which one of the following must equal zero if a firm pays a constant annual dividend? A) ROE B) Growth rate C) Total return D) Par value per share E) Book value per share

B) Growth rate

Which one of the following is a capital budgeting decision? A) determining how much equity to be issued B) deciding whether or not to acquirer a private company C) deciding when to issue a 10-year bond D) determining how much cash to keep on hand E) determining how much dividend should be paid out next quarter

B) deciding whether or not to acquirer a private company

Healthy Foods just paid its annual dividend of $1.62 a share. The firm recently announced that all future dividends will be increased by 2.1 percent annually. What is one share of this stock worth to you if you require a rate of return of 15.7 percent? A) $11.91 B) $12.95 C) $12.16 D) $10.54 E) $13.07

C) $12.16 Explanation: P0 = $1.62 × (1+.021) / (.157 − .021) = $12.16

The preferred stock of Federal Logistics is selling for $57.56 per share. The company pays a constant annual dividend and has a total return of 10.13 percent. What is the amount of the dividend? A) $3.53 B) $3.55 C) $5.83 D) $6.20 E) $5.31

C) $5.83 Explanation: D = .1013 × $57.56 = $5.83

Sugar Cookies will pay an annual dividend of $1.23 a share next year. The firm expects to increase this dividend by 8 percent per year the following four years and then decrease the dividend growth to 2 percent annually thereafter. Which one of the following is the correct computation of the dividend for Year 7? A) 1.23× (1.08 × 4) × (1.02 × 3) B) 1.23× (1.08 × 4) × (1.02 × 2) C) 1.23× (1.08)4 × (1.02)2 D) 1.23× (1.08)4 × (1.02)3 E) 1.23× (1.08)4 × (1.02)4

C) 1.23× (1.08)4 × (1.02)2

Which one of the following analytical methods is based on net income? A) Payback B) Internal rate of return C) Average accounting return D) NPV

C) Average accounting return

Which one of the following statements is correct? A) A longer payback period is preferred over a shorter payback period. B) The payback rule states that you should accept a project if the payback period is less than one year. C) The payback period ignores the time value of money. D) The payback rule is biased in favor of long-term projects. E) The payback period considers the timing and amount of all of a project's cash flows.

C) The payback period ignores the time value of money.

Dividends are best defined as: A) cash payments to shareholders. B) cash payments to either bondholders or shareholders. C) cash or stock payments to shareholders. D) cash or stock payments to either bondholders or shareholders. E) distributions of stock to current shareholders.

C) cash or stock payments to shareholders.

The three simplifying assumptions that cover most stock growth patterns are A) dividends that stay constant over time, dividends that grow at a constant rate, and dividends that are equal to zero. B) dividends that have a zero-growth rate, dividends that grow at a varying rate, and dividends that are equal to zero. C) dividends that stay constant over time, dividends that grow at a constant rate, and dividends that have a mixed growth pattern. D) None of the above.

C) dividends that stay constant over time, dividends that grow at a constant rate, and dividends that have a mixed growth pattern.

Sunk costs include any cost that: A) will change if a project is undertaken .B) will be incurred if a project is accepted. C) has previously been incurred and cannot be changed .D) has been paid to a third party and is refundable if a project fails. E) will occur if a project is accepted and once incurred, cannot be recouped.

C) has previously been incurred and cannot be changed

The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as: A) duplication. B) the net present value profile. C) multiple rates of return. D) the AAR problem. E) the dual dilemma.

C) multiple rates of return.

The Glass Ceiling paid an annual dividend of $1.64 per share last year and just announced that future dividends will increase by 1.3 percent annually. What is the amount of the expected dividend in Year 6? A) $1.43 B) $1.75 C) $1.46 D) $1.77 E) $1.58

D) $1.77 Explanation: D6 = $1.64 × (1.013)6 = $1.77

Owners of preferred stock _____ A) have no voting rights most times. B) usually receive fixed dividend payments. C) are given priority treatment over common stock with respect to dividends payments and the claims against the firm's assets in the event of bankruptcy or liquidation. D) All of the other statements are true.

D) All of the other statements are true.

Which one of the following statements is correct? A) Net present value is equal to an investment's cash inflows discounted to today's dollars. B) The net present value is positive when the required return exceeds the internal rate of return. C) If the initial cost of a project is increased, the net present value of that project will also increase. D) If the internal rate of return equals the required return, the net present value will equal zero.

D) If the internal rate of return equals the required return, the net present value will equal zero.

The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following? A) One of the time periods within the investment period has a cash flow equal to zero. B) The initial cash flow is negative. C) The investment has cash inflows that occur after the required payback period. D) The investment is mutually exclusive with another investment of a different size.

D) The investment is mutually exclusive with another investment of a different size.

The payback method of analysis ignores which one of the following? A) Initial cost of an investment B) Arbitrary cutoff point C) Cash flow direction D) Time value of money E) Timing of each cash inflow

D) Time value of money

The average net income of a project divided by the project's average book value is referred to as the project's: A) required return. B) market rate of return. C) internal rate of return. D) average accounting return. E) discounted rate of return.

D) average accounting return.

6. The net working capital invested in a project is generally: A) just an accounting number so should be ignored. B) an opportunity cost. C) recouped in the first year of the project. D) recouped at the end of the project. E) depreciated to a zero balance over the life of the project.

D) recouped at the end of the project.

Braxton's Cleaning Company stock is selling for $32.60 a share based on a rate of return of 13.8 percent. What is the amount of the next annual dividend if the dividends are increasing by 2.4 percent annually?

D1 = $32.60 × (.138 − .024) = $3.72

. Which of the following are examples of an incremental cash flow? I. an increase in accounts receivable II. a decrease in net working capital III. an increase in taxes IV. a decrease in the cost of goods sold A) I and III only B) III and IV only C) I and IV only D) I, III, and IV only E) I, II, III, and IV

E) I, II, III, and IV

Which one of the following indicates that a project should be rejected? Assume the cash flows are normal, i.e., the initial cash flow is negative. A) Average accounting return that exceeds the requirement B) Payback period that is shorter than the requirement period C) Positive net present value D) Zero net present value E) Internal rate of return lower than the required return

E) Internal rate of return lower than the required return

Newly issued securities are sold to investors in which one of the following markets? A) Proxy B) Stated value C) Inside D) Secondary E) Primary

E) Primary

The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to: A) produce a positive annual cash flow. B) produce a positive cash flow from assets. C) offset its fixed expenses. D) offset its total expenses. E) recoup its initial cost.

E) recoup its initial cost.

A project has the following cash flows. What is the payback period? Year Cash Flow 0 −$45,000 1 20,000 2 23,500 3 24,000 4 25,000

Explanation: Payback = 2 + ($45,000 − 20,000 − 23,500) / $24,000 = 2.06 years

What is the net present value of the following cash flows if the relevant discount rate is 5.75 percent? Year Cash Flow 0 $11,400 1 −2,500 2 −2,500 3 −9,500

NPV = $11,400 + (−$2,500 / 1.0575) + (−$2,500 / 1.05752) + (−$9,500 / 1.05753) NPV = −$1,232.68

Soft and Cuddly is considering a new toy that will produce the following cash flows. Should the company produce this toy based on IRR if the firm requires a rate of return of 17.5 percent? Year Cash Flow 0 −$132,000 1 97,000 2 42,000 3 28,000

NPV = 0 = −$132,000 + $97,000 / (1 + IRR) + $42,000 / (1 + IRR)2 + $28,000 / (1 + IRR)3 IRR = 16.45 percent The project should be rejected because its IRR is less than the required rate of return.

Diamond Enterprises is considering a project that will produce cash inflows of $41,650 a year for three years followed by $49,000 in Year 4. What is the internal rate of return if the initial cost of the project is $219,000?

NPV = 0 = −$219,000 + $41,650 / (1 + IRR) + $41,650 / (1 + IRR)2 + $41,650 / (1 + IRR)3 + $49,000 / (1 + IRR)4 IRR = 8.42 percent

You are making an investment of $110,000 and require a rate of return of 14.6 percent. You expect to receive $48,000 in the first year, $52,500 in the second year, and $55,000 in the third year. There will be a cash outflow of $900 in the fourth year to close out the investment. What is the net present value of this investment?

NPV = −$110,000 + $48,000 / 1.146 + $52,500 / 1.1462 + $55,000 / 1.1463 + (−$900 / 1.1464) NPV = $7,881.55

What is the net present value of a project with the following cash flows if the discount rate is 9 percent? Year Cash Flow 0 −$55,000 1 21,500 2 24,750 3 29,450

NPV = −$55,000 + $21,500 / 1.09 + $24,750 / 1.092 + $29,450 / 1.093 NPV = $8,297.15

Spiral Staircase is offering preferred stock which is referred to as 10-10 stock. This stock will pay an annual dividend of $10 a share starting 10 years from now. What is this stock worth to you today if you require a rate of return of 9.5 percent?

P0 = ($10 / .095) / 1.0959 = $46.51

The Impulse Shopper recently paid an annual dividend of $1.13 per share. The company just announced that it is suspending all dividend payments on its common stock for the next five years. After that, the company expects to pay $.50 a share at the end of each year. At a required return of 18 percent, what is this stock worth today?

P0 = ($.50/.18) / (1 + .18)5 = $1.21

Flash Freeze Frozen Foods is expected to pay annual dividends of $1.34 and $1.45 at the end of the next two years, respectively. After that, the company expects to pay a constant dividend of $1.50 a share. What is the value of this stock at a required return of 15.1 percent?

P2 = D/R = $1.50 /.151 = $9.93 P0 = [$1.34 / 1.151] + [($1.45 + 9.93)/1.1512] = $9.76

Baker's Supply imposes a payback cutoff of 3.5 years for its international investment projects. If the company has the following two projects available, which project(s), if either, should it accept? Year Cash Flow (A) Cash Flow (B) 0 −$62,000 −$26,000 1 7,100 15,600 2 9,800 8,400 3 28,700 1,900 4 45,900 1,100

PaybackA = 3 + [($62,000 − 7,100 − 9,800 − 28,700)/$45,900] = 3.36 years PaybackB = 3 + [($26,000 − 15,600 − 8,400 − 1,900)/$1,100 = 3.09 years The firm should accept both projects.

Sweet Treats pays a constant annual dividend of $2.38 a share and currently sells for $52.60 a share. What is the rate of return?

R = $2.38 / $52.60 = .0452, or 4.52 percent

Today, Sweet Snacks is investing $491,000 in a new oven. As a result, the company expects its cash flows to increase by $64,000 a year for the next two years and by $98,000 a year for the following three years. How long must the firm wait until it recovers all of its initial investment?

The project never pays back because the total cash inflow is only $422,000.

Dry Dock Marina is expected to pay an annual dividend of $1.58 next year. The stock is selling for $18.53 a share and has a total return of 9.48 percent. What is the dividend growth rate?

g = .0948 − ($1.58/$18.53) = .0095, or .95 percent