FINA Chapter 7

The most recent paid dividend (Div0) is $1.80, the growth rate (g) is 6%, and the required rate of return (r) is 12%. What is the stock price according to the constant growth dividend model?

The constant growth dividend model states that P0 = Div0 x (1 + g)/(r - g) = Div1/(r-g). Inserting our values gives: P0 = $1.80 x 1.06/(0.12 - 0.06) = $1.908/0.06 = $31.80

Sedgwick, Inc. has a 12% required rate of return. It does not expect to initiate dividends for 15 years, at which time it will pay $2.00 per share in dividends. At that time, Sedgwick expects its dividend to grow at 7% forever. If you currently own the stock and will sell it following the first dividend, what is your estimated selling price at T15.

We use the formula P15 = Div15 x (1 + g)/(r - g). Inserting our given values, we get P15 = $2.00 x (1 + 0.07)/(0.12 - 0.07) = $2.14/0.05 = $42.80

Kwak Motors, Inc. pays a $1.77 preferred dividend every quarter and will maintain this policy forever. What price should you pay for one share of preferred stock if you want an annual return of 9.25% on your investment?

When computing a perpetuity, we have to make sure both the payment and the discount rate represent the same period. In this problem, let us use three months as our period. Thus, we restate the annual required rate of 9.25% as a quarterly (or three-month) rate of 9.25%/4 = 2.3125% (or 0.023125). Applying the constant dividend forever formula with the quarterly rate of return and a quarterly dividend of $1.77, we get: $1.77/0.023125 = $76.54. We can get the same answer using annual date. For example, the annual dividend is 4 x $1.77 = $7.08. Thus, price = $7.08/0.0925 = $76.54

A typical practice of many companies is to distribute part of the earnings to share-holders through ___.

b. quarterly cash dividends

Stocks are different from bonds because ___.

b. stocks, unlike bonds, represent residual ownership Stocks and bonds are both major sources of funds. Bonds do not represent residual ownership. Bonds, unlike stocks, give owners legal claims to payments. Stocks, unlike bonds, represent voting ownership.

You want to invest in a stock that pays $6.00 annual cash dividends for the next five years. At the end of the five years, you will sell the stock for $30. If you want to earn 10% on this investment, what is a fair price for this stock if you buy it today?

The fair price is the present value of the selling price plus the present value of the dividend stream. Thus, today's price (P) = (future price x PVIF) + (dividend stream x PVIFA) = ($30 x 0.620921) + ($6 x 3.790787) = $18.628 + $22.745 = $41.37

Which of the following statements is true?

c. The ask price is the price at which. dealer is willing to sell, and the bid price is the price at which a dealer is willing to buy. The dealers make money on the difference between what they buy the stock for and what they sell it for, much like a car dealer makes money by buy-in g used car at one price and then selling the car later at a higher or marked-up price. A bull market is prolonged rising market, one in which stock princes in general are increasing. A bear market is a prolonged declining market, one in which stock prices in general are decreasing.

Dividend models suggest the ___ determine the value of a financial asset to which the owners is entitled while holding the asset.

c. future cash flows Dividend models do not focus on past and present cash flows but, rather, on future cash flows that are discounted by a required rate of return.

Which of the following statements is false?

d. Most companies have the resident expertise to complete an initial public offering or first public equity issue. Most companies do not have the resident expertise to complete an initial public offering or first public equity issue

Which of the following statements is true?

d. Some preferred stocks are cumulative in dividends, meaning that if a company skips a cash dividend, it must pay it at some point in the future. The preferred stock usually has a stated or par value, but, unlike bonds, this par value is not repaid at maturity because preferred stocks do not have a maturity date. The only time this par value would be paid to the shareholder is if the company ceases operations or retires the preferred stock. The cash dividend due each year is based on the stated dividend rate times the par value of the stock.