Chapter 11
The growth rate in equity without any external financing is determined by multiplying the payout ratio times the return on equity (ROE).
False
Dividend growth is a function of a. Return on equity. b. The retention rate. c. The payout ratio. d. All of the above. e. None of the above.
D
The price of a bond can be calculated by discounting future coupons over the bonds life by the yield to maturity.
False
If the intrinsic value of an asset is greater than the market price, you would want to buy the investment.
True
The importance of an industry's performance on an individual stock's performance varies across industries.
True
Exhibit 11.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A major manufacturer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds were issued with an 8 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 10 percent. Refer to Exhibit 11.2. What is the current value of these securities? a. $900.18 b. $1151.92 c. $972.52 d. $1113.63 e. $904.00
A
In 2004, Smiths Corp. issued a $50 par value preferred stock that pays a 6 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring an 7 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $42.86 b. $30.00 c. $31.54 d. $33.38 e. $38.37
ANS: A Dividend = .06 $50 = $3 Price = 3 0.07 = $42.85
The Absolute Finance Company (AFC) earned $5 a share last year and paid a dividend of $2 per share. Next year, you expect AFC to earn $6 a share next year and continue its payout ratio. Assume that you expect to sell the stock for $45 a year from now. If you require a 13 percent return on this stock, how much would you be willing to pay for it? a. $41.95 b. $43.21 c. $45.13 d. $46.72 e. $47.40
ANS: A Expected dividend in one year = (2/5)(6) = $2.40 Value today = ($45 + $2.40)/(1.13) = $41.95
All of the following are ways in which a firm can increase its growth rate of equity earnings without any external financing except a. Decreasing its dividend payments b. Increasing its retention ratio c. Increasing its return on equity (ROE) d. Increasing its return on assets (ROA) e. All of the above will increase the firm's growth rate without external financing
E
A bond typically pays interest payments every six months equal to the coupon rate times the face value of the bond.
False
Discounted cash flow techniques for equity valuation may use one of the following: (1) dividends, (2) Free cash flow or (3) coupons.
False
Fundamentalists typically use the "Bottom-Up Approach" whereas technicians use the "Top-Down Approach" to the valuation process.
False
An equity investor's required rate of return is influenced by the economy's real risk-free rate, the expected rate of inflation, and a risk premium.
True
An example of a relative valuation technique is the Price/Cash Flow ratio.
True
If the estimated value of an asset is greater than the market price, you would want to buy the investment.
True
The dividend discount model (DDM) can be used to value preferred stock by simply using a growth rate of zero in the DDM model.
True
The dividend growth models are only meaningful for companies that have a required rate of return that exceeds their dividend growth rate.
True
The general economic influences would include inflation, political upheavals, monetary policy, and fiscal policy initiatives.
True
The most difficult part of valuing a bond is determining the required rate of return on this investment.
True
The real risk free rate depends on the real growth in the economy and can be affected for short time periods by temporary tightness or ease in the capital markets.
True
The risk premium is impacted by business risk, financial risk, and liquidity risk.
True
The two components that are required in order to carry out asset valuation are (1) the stream of expected cash flows and (2) the required rate of return.
True
The value of preferred stock can be calculated by dividing its dividend by the required rate of return.
True
Exhibit 11.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The National Motor Company's last dividend was $1.25 and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share. Refer to Exhibit 11.5. How much should you be willing to pay for the stock if you feel that the 7 percent growth rate can be maintained indefinitely and you require a 16 percent return? a. $11.15 b. $14.44 c. $14.86 d. $18.90 e. $19.24
ANS: C P = (1.25 1.07) (0.16 0.07) = $14.86
Refer to Exhibit 11.6. The price of the stock today (P0) is a. $136.29 b. $133.03 c. $120.33 d. $123.43 e. $126.60
ANS: C P0 = PV of dividends yr1 to yr5 + PV of P5 = 10.28 + 154.35/(1.07)5 = $120.33
Using the constant growth model, an increase in the required rate of return from 14 to 18 percent combined with an increase in the growth rate from 8 to 12 percent would cause the price to a. Fall more than 4% b. Fall less than 4%. c. Rise more than 4% d. Rise less than 4%. e. Remain constant.
ANS: D % = P2/P1 = [(D0)(1 + g2)/(k2 g2)] [(D0)(1 + g1)/(k1 g1)] 1 = [(D0)(1 + 0.12)/(0.18 0.12)] [(D0)(1 + 0.08)/(0.14 0.08)] 1 = (18.66 18.00) 1 = 3.77% < 4%
In 2004, Montpelier Inc. issued a $100 par value preferred stock that pays a 9 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 10 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $100 b. $110 c. $75 d. $90 e. $85
ANS: D Dividend = .09 $100 = $9 Price = 9 0.1 = $90
Exhibit 11.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.7. The future price of the stock in year 3 is a. $81.75 b. $84.81 c. $92.56 d. $101.85 e. $111.16
ANS: D Future price of stock in year 3 = P3 = D4/(k g) where g is the normal growth rate = 5% D4 = 1.5(1 + .09)3(1 + .05) = $2.037 P3 = 2.037/(.07 .05) = $101.85
Exhibit 11.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A large grocery chain is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 6 years remaining until maturity. The bonds were issued with a 6 percent coupon rate (paid semiannually) and a par value of $1,000. Because of increased risk the required rate has risen to 10 percent. Refer to Exhibit 11.3. What will be the value of these securities in one year if the required return declines to 8 percent? a. $899.43 b. $862.50 c. $869.88 d. $918.93 e. $946.98
ANS: D P = 30(PVIFA4%,10) + 1000(PVIF4%,10) P = 30(8.1109) + 1000(.6756) = $918.93
Exhibit 11.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Davenport Corporation's last dividend was $2.70 and the directors expect to maintain the historic 3 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5 percent for the next three years and the stock will then reach $25 per share. Refer to Exhibit 11.4. How much should you be willing to pay for the stock if you require a 17 percent return? a. $16.97 b. $22.16 c. $21.32 d. $32.63 e. $23.63
B
According to the dividend growth model, if a company were to declare that it would never pay dividends, its value would be a. Based on earnings. b. Based on expectations regarding. c. Higher than similar firms since it could reinvest a greater amount in new projects. d. Zero. e. Based on the capital asset pricing model.
D
Tayco Corporation has just paid dividends of $3 per share. The earnings per share for the company was $4. If you believe that the appropriate discount rate is 15% and the long term growth rate in dividends is 6%, and earnings is 6%, the firm's P/E ratio is a. 8.33 b. 33.33 c. 44.44 d. 11.11 e. None of the above
A
Using the constant growth model, a decrease in the required rate of return from 15 to 13 percent combined with an increase in the growth rate from 5 to 6 percent would cause the price to a. Rise more than 50%. b. Rise less than 50%. c. Remain constant. d. Fall more than 50%. e. Fall less than 50%.
%= P2/P1 = [(D0)(1 + g2)/(k2 g2)] [(D0)(1 + g1)/(k1 g1)] 1 = [(D0)(1 + 0.06)/(0.13 0.06)] [(D0)(1 + 0.05)/(0.15 0.05)] 1 = (15.14 10.5) 1 = 44.22% < 50%
What is the value of a preferred stock that has a par value of $100, a required rate of return of 11%, and pays a 7 percent annual dividend? a. $63.64 b. $157.14 c. $909.09 d. $1,428.57 e. $2,500.00
ANS: A Dividend = .07*$100 = $7. Value of a perpetuity = D/k = $7/.11 = $63.64
Exhibit 11.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A major retailer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 8 years remaining until maturity. The bonds were issued with a 6.5 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 4.25 percent. Refer to Exhibit 11.1. What is the current value of these securities? a. $1149.94 b. $433.15 c. $1151.92 d. $860.50 e. $863.35
C
Exhibit 11.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A major manufacturer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds were issued with an 8 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 10 percent. Refer to Exhibit 11.2. What will be the value of these securities in one year if the required return is 6 percent? a. $1151.92 b. $972.52 c. $1100.15 d. $900.18 e. $936.72
C
Growth rates of the (1) labor force, (2) average number of hours worked and (3) labor productivity are the main determinants of a foreign country's a. Dividend payout ratio. b. Beta. c. Real risk free rate. d. Nominal risk free rate. e. Risk premium.
C
Micro Corp. just paid dividends of $2 per share. Assume that over the next three years dividends will grow as follows, 5% next year, 15% in year two, and 25% in year 3. After that growth is expected to level off to a constant growth rate of 10% per year. The required rate of return is 15%. Calculate the intrinsic value using the multistage model. a. $5.56 b. $66.4 c. $49.31 d. $43.66 e. none of the above
C
Which securities can be valued by dividing the annual dividend by the required rate of return? a. Low coupon bonds b. Junk bonds c. Common stocks d. Preferred stocks e. Constant growth common stocks
D
The three step valuation process consists of (1) analysis of alternative economies and markets, (2) analysis of alternative industries and (3) analysis of industry influences.
False
The required rate of return is determined by (1) the real risk free rate, (2) the expected rate of inflation and (3) liquidity risk.
False
Which of the following statements regarding fundamental and relative valuation techniques is true? a. Both techniques require an appropriate estimate of the required rate of return and the growth rate. b. Both techniques require an estimate of future cash flows and a discount rate. c. Both techniques require an estimate of future cash flows and a growth rate. d. Both techniques require an estimate of future cash flows, the required rate of return and a growth estimate. e. All of the above are true.
A
In 2004, Swisten Inc. issued a $150 par value preferred stock that pays an 8 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring an 15 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $80 b. $75 c. $59 d. $95 e. $110
ANS: A Dividend = .08 $150 = $12 Price = 12 0.15 = $80
The P/E ratio for BMI Corporation is 21, and the P/S ratio is 5.2. The industry P/E ratio is 35 and the industry P/S ratio is 7.5. Based on relative valuation, BMI is a. undervalued on the basis of relative P/E and relative P/S. b. overvalued on the basis of relative P/E and undervalued on the basis of relative P/S. c. undervalued on the basis of relative P/E and overvalued on the basis of relative P/S. d. overvalued on the basis of relative P/E and relative P/S. e. none of the above.
ANS: A Relative P/E = 21/35 = undervalued Relative P/S = 5.2/7.5 = undervalued
Exhibit 11.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.7. The present value today of dividends for years 1 to 3 is a. $4.67 b. $3.08 c. $5.67 d. $4.5 e. $1.53
ANS: A The present value today of dividends from years 1 to 3 = 1.64/(1.07) +1.78/(1.07)2 + 1.94/(1.07)3 = $4.67
The beta for the DAK Corporation is 1.25. If the yield on 30 year T-bonds is 5.65%, and the long term average return on the S&P 500 is 11%. Calculate the required rate of return for DAK Corporation. a. 12.34% b. 7.06% c. 13.74% d. 5.35% e. 5.65%
ANS: A required return = .0565 + 1.25(.11 .0565) = 12.34%
Hunter Corporation had a dividend payout ratio of 63% in 1999. The retention rate in 1999 was a. 37% b. 63% c. 50% d. 0% e. 100%
ANS: A retention rate = 1 .63 = 37%
Using the constant growth model, an increase in the required rate of return from 14 to 15 percent combined with an increase in the growth rate from 6 to 7 percent would cause the price to a. Rise more than 1% b. Rise less than 1%. c. Remain constant. d. Fall more than 1%. e. Fall less than 1%.
ANS: B % = P2/P1 = [(D0)(1 + g2)/(k2 g2)] [(D0)(1 + g1)/(k1 g1)] 1 = [(D0)(1 + 0.07)/(0.15 0.07)] [(D0)(1 + 0.06)/(0.14 0.06)] 1 = (13.375 13.25) 1 = 0.94% < 1%
Using the constant growth model, an increase in the required rate of return from 19 to 17 percent combined with an increase in the growth rate from 11 to 9 percent would cause the price to a. Fall more than 2% b. Fall less than 2%. c. Remain constant. d. Rise more than 2%. e. Rise less than 3%.
ANS: B % = P2/P1 = [(D0)(1 + g2)/(k2 g2)] [(D0)(1 + g1)/(k1 g1)] 1 = [(D0)(1 + 0.09)/(0.17 0.09)] [(D0)(1 + 0.11)/(0.19 0.11)] 1 = (13.625 13.875) 1 = 1.8% > 2%
Using the constant growth model, an increase in the required rate of return from 17 to 20 percent combined with an increase in the growth rate from 8 to 11 percent would cause the price to a. Rise more than 3% b. Rise less than 3%. c. Remain constant. d. Fall more than 3%. e. Fall less than 3%.
ANS: B % = P2/P1 = [(D0)(1 + g2)/(k2 g2)] [(D0)(1 + g1)/(k1 g1)] 1 = [(D0)(1 + 0.11)/(0.20 0.11)] [(D0)(1 + 0.08)/(0.17 0.08)] 1 = (12.33 12.00) 1 = 2.75% < 3%
Exhibit 11.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Fast Grow Corporation is expecting dividends to grow at a 20% rate for the next two years. The corporation just paid a $2 dividend and the next dividend will be paid one year from now. After two years of rapid growth dividends are expected to grow at a constant rate of 9% forever. Refer to Exhibit 11.8. Assume that the annual dividend grows at a constant rate of 9% indefinitely instead of the supernormal growth. How much is the stock worth if dividends grow annually at 9%? a. $40.00 b. $43.60 c. $45.60 d. $47.80 e. $52.40
ANS: B P = $2(1.09)/(.14 .09) = 2.18/.05 = $43.60
Exhibit 11.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.7. The price of the stock today (P0) is a. $84.81 b. $87.81 c. $91.09 d. $94.32 e. $97.61
ANS: B P0 = PV of dividends yr1 to yr5 + PV of P3 = 4.67 + 101.85/(1.07)3 = $87.81
Exhibit 11.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.6. The present value today of dividends for years 1 to 5 is a. $4.06 b. $10.28 c. $12.40 d. $14.52 e. $10.00
ANS: B The present value today of dividends from years 1 to 5 = 2.16/(1.07) + 2.33/(1.07)2 + 2.52/(1.07)3 + 2.72/(1.07)4 + 2.94/(1.07)5 = $10.28
Exhibit 11.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.7. The dividends for years 1, 2, and 3 are a. $1.5, $2.0, $2.05 b. $1.64, $1.78, $1.94 c. $1.64, $1.94, $2.24 d. $1.5, $2.40, $3.30 e. $2.07, $2.14, $2.21
ANS: B Year 1 Dividends = 1.5(1 + .09) = $1.64 Year 2 Dividends = 1.5(1 + .09)2 = $1.78 Year 3 Dividends = 1.5(1 + .09)3 = $1.94
Exhibit 11.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A large grocery chain is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 6 years remaining until maturity. The bonds were issued with a 6 percent coupon rate (paid semiannually) and a par value of $1,000. Because of increased risk the required rate has risen to 10 percent. Refer to Exhibit 11.3. What is the current value of these securities? a. $656.40 b. $899.00 c. $822.70 d. $569.50 e. $962.00
ANS: C P = 30(PVIFA5%,12) + 1000(PVIF5%,12) P = 30(8.8633) + 1000(.5568) = $822.70
Exhibit 11.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Davenport Corporation's last dividend was $2.70 and the directors expect to maintain the historic 3 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5 percent for the next three years and the stock will then reach $25 per share. Refer to Exhibit 11.4. How much should you be willing to pay for the stock if you feel that the 5 percent growth rate can be maintained indefinitely and you require a 17 percent return? a. $22.16 b. $19.28 c. $21.32 d. $23.63 e. $25.46
ANS: D P = (2.70 1.05) (0.17 0.05) = $23.63
Exhibit 11.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.6. The dividends for years 1, 2, and 3 are a. $2, $2.08, $2.16 b. $2, $2.05, $2.10 c. $2.16, $2.24, $2.32 d. $2.16, $2.33, $2.52 e. $2.07, $2.14, $2.21
ANS: D Year 1 Dividends = 2(1 + .08) = $2.16 Year 2 Dividends = 2(1 + .08)2 = $2.33 Year 3 Dividends = 2(1 + .08)3 = $2.52
In 2004, Venus Fly Co. issued a $75 par value preferred stock which pays a 7 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 5 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $125 b. $84 c. $91 d. $145 e. $105
ANS: E Dividend = .07 $75 = $5.25 Price = 5.25 0.05 = $105
Exhibit 11.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%. Refer to Exhibit 11.6. The future price of the stock in year 5 is a. $113.40 b. $122.47 c. $132.27 d. $142.85 e. $154.35
ANS: E Future price of stock in year 5 = P5 = D6/(k g) where g is the normal growth rate = 5% D6 = 2(1 + .08)5(1 + .05) = $3.087 P5 = 3.087/(.07 .05) = $154.35
XCEL Corporation paid a dividend yesterday for $1.50. They expect to pay dividends annually at a constant 6% annual growth rate indefinitely. If the required rate of return on this investment is 12%, what is the current value of this common stock? a. $1.50 b. $12.50 c. $13.25 d. $25.00 e. $26.50
ANS: E Using the DDM: P = $1.50(1.06)/(.12 .06) = $1.59/.06 = $26.50
A company's dividend last year was $3.00. Dividends are expected to grow indefinitely at 7% and the required rate of return for the stock is 13%. What is the value of the stock today? a. $2.83 b. $23.08 c. $24.69 d. $50.00 e. $53.50
ANS: E Value of stock today = $3.00(1.07)/(.13 .07) = $3.21/0.06 = $53.50
Ross Corporation paid dividends per share of $1.20 at the end of 1990. At the end of 2000 it paid dividends per share of $3.50. Calculate the compound annual growth rate in dividends. a. 52.17% b. 34.28% c. 23% d. 19.17% e. 11.29%
ANS: E g = (3.50/1.20)1/10 1 = 11.29%
A company has a dividend payout ratio of 35 percent. If the company's return on equity is 15 percent, what is the expected growth rate if no new outside financing is used? a. 4.50% b. 5.25% c. 7.75% d. 8.25% e. 9.75%
ANS: E g = RR(ROE) = (1 .35)(.15) = 0.0975 or 9.75%
The most appropriate discount rate to use when applying the Operating Free Cash Flows model is the firm's a. Required rate of return based on the capital asset pricing model (CAPM) b. Required rate of return based on the dividend discount model (DDM) c. Weighted average cost of capital (WACC) d. Historical cost of debt and equity e. All of the above are appropriate depending on the situation
C
The value of a corporate bond can be derived by calculating the present value of the interest payments and the present value of the face value at the bond's a. Current yield. b. Coupon rate. c. Required rate of return. d. Effective rate. e. Prime rate.
C
What is the value of a 10% semi-annual coupon bond with a par value of $1,000 that matures in 5 years and has a required rate of return of 9%? a. $1,021.95 b. $1,038.90 c. $1,039.56 d. $1,064.18 e. $1,078.23
C
Exhibit 11.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The National Motor Company's last dividend was $1.25 and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share. Refer to Exhibit 11.5. How much should you be willing to pay for the stock if you require a 16 percent return? a. $17.34 b. $18.90 c. $19.09 d. $19.21 e. None of the above
D
Exhibit 11.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Fast Grow Corporation is expecting dividends to grow at a 20% rate for the next two years. The corporation just paid a $2 dividend and the next dividend will be paid one year from now. After two years of rapid growth dividends are expected to grow at a constant rate of 9% forever. Refer to Exhibit 11.8. If the required return is 14%, what is the value of Fast Grow Corporation common stock today? a. $40.26 b. $42.38 c. $46.70 d. $52.63 e. $62.78
D
The growth rate of equity earnings without external financing is equal to a. Retention rate plus return on equity. b. Retention rate minus return on equity. c. Retention rate divided by return on equity. d. Retention rate times return on equity. e. Return on equity divided by retention rate.
D
The process of fundamental valuation requires estimates of all the following factors, except a. The time pattern of returns. b. The economy's real risk-free rate. c. The risk premium for the asset. d. The times series of stock prices. e. The expected rate of inflation.
D
Which of the following factors influence an investor's required rate of return? a. The economy's real risk-free rate (RFR) b. The expected rate of inflation (I) c. A risk premium d. All of the above e. None of the above
D
Which of the following is an underlying assumption of the constant growth dividend discount model (DDM)? a. Dividends have a constant growth rate b. The constant growth rate of dividends will continue for an infinite time period c. The required rate of return is greater than the expected growth rate d. All of the above e. None of the above
D
Which of the following is not considered a basic economic force? a. Fiscal policy b. Monetary policy c. Inflation d. P/E ratio e. None of the above (that is, all are basic economic forces)
D
What is the value to you of a 10 percent coupon bond with semi-annual coupon payments and a par value of $10,000 that matures in 20 years if you require an 8 percent return? a. $9,652.89 b. $10,356.65 c. $11,359.03 d. $11,979.28 e. $12,385.62
D Using the calculator TVM functions PMT = Coupon payments = .10($10,000)/2 = $1,000/2 = $500 N = number of 6-month periods = 20*2 = 40 I/Y = required rate of return/2 = 8%/2 = 4% FV = Par Value = $10,000 Compute for PV = value today = $11,979.28
Exhibit 11.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A major retailer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 8 years remaining until maturity. The bonds were issued with a 6.5 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 4.25 percent. Refer to Exhibit 11.1. What will be the value of these securities in one year if the required return is 7 percent? a. $970.14 b. $388.13 c. $1031.15 d. $1035.81 e. $972.52
E
The P/E ratio is determined by a. The required rate of return. b. The expected dividend payout ratio. c. The expected growth rate of dividends. d. Choices a and b e. All of the above
E
Which of the following is correct? a. If estimated value > Market price, you should buy. b. If estimated value > Market price, you should sell. c. If estimated value < Market price, you should sell. d. If estimated value < Market price, you should buy. e. Choices a and c.
E
Which of the following is not a consideration in the three-step valuation process? a. Analysis of alternative economies b. Analysis of security markets c. Analysis of alternative industries d. Analysis of individual companies e. None of the above (that is, all are considerations in the three-step valuation process)
E
Empirical studies have shown that the market factor has increased over time and now accounts for the majority of an individual stock's price variance.
False
Given an optimistic economic and stock-market outlook for a country, the investor should underweight the allocation to this country in his/her portfolio.
False
Growth companies are those firms that consistently earn higher rates of return by assuming greater amounts of risk.
False
In dividend discount models (DDM) with supernormal growth, supernormal growth may continue indefinitely.
False
The growth rate of dividends and profit margin are the main determinants of the P/E ratio.
False
The infinite period dividend discount model (DDM) can be used to value a supernormal growth company.
False
A preferred stock is a perpetuity.
True
A relative valuation technique is appropriate to consider when you have a good set of comparable entities.
True
