Chapter Nine Valuation of Common Stocks This chapter contains 47 multiple choice questions,17 short problems,and 9 longer problems. Multiple Choice 1.In a quote listing of stocks,the is defined as the annualized dollar dividend divided by the stock's price,and is usually expressed as a percentage. (a)cash dividend (b)dividend payout (c)dividend coverage (d)dividend yield Answer:(d) 2.According to the discounted-dividend model,the price of a share of stock is the value of all expected dividends per share,discounted at the market capitalization rate. (a)present;current (b)present:future (c)future:future (d)future;current Answer:(b) 3.The value of common stock is determined by which of the following expected cash flows? (a)dividends and interest payments (b)dividends and maturity value of stock (c)dividends and net cash flows from operations of the firm (d)interest payments and maturity value Answer:(c) 9-1
9-1 Chapter Nine Valuation of Common Stocks This chapter contains 47 multiple choice questions, 17 short problems, and 9 longer problems. Multiple Choice 1. In a quote listing of stocks, the ________ is defined as the annualized dollar dividend divided by the stock’s price, and is usually expressed as a percentage. (a) cash dividend (b) dividend payout (c) dividend coverage (d) dividend yield Answer: (d) 2. According to the discounted-dividend model, the price of a share of stock is the ________ value of all expected ________ dividends per share, discounted at the market capitalization rate. (a) present; current (b) present; future (c) future; future (d) future; current Answer: (b) 3. The value of common stock is determined by which of the following expected cash flows? (a) dividends and interest payments (b) dividends and maturity value of stock (c) dividends and net cash flows from operations of the firm (d) interest payments and maturity value Answer: (c)
4.The is the expected rate of return that investors require in order to be willing to invest in the stock (a)market capitalization rate (b)risk-adjusted discount rate (c)cost of debt (d)a and b Answer:(d) 5.The of dividends is the most basic assumption underlying the discounted dividend model. (a)industry average (b)non-constant growth (c)constant growth (d)variability Answer:(c) 6. BHM stock is expected to pay a dividend of $2.50 a year from now,and its dividends are expected to grow by 6%per year thereafter.What is the price of a BHM share if the market capitalization rate is 7%per year? (a)$250.00 (b)$192.31 (c)$25.00 (d)$19.23 Answer:(c) 7.IOU stock is expected to pay a dividend of $1.67 a year from now,and its dividends are not expected to grow in the foreseeable future.If the market capitalization rate is 7%,what is the current price of a share of IOU stock? (a)$11.69 (b)$23.86 (c)$116.90 (d)$238.60 Answer:(b) 9-2
9-2 4. The ________ is the expected rate of return that investors require in order to be willing to invest in the stock. (a) market capitalization rate (b) risk-adjusted discount rate (c) cost of debt (d) a and b Answer: (d) 5. The ________ of dividends is the most basic assumption underlying the discounted dividend model. (a) industry average (b) non-constant growth (c) constant growth (d) variability Answer: (c) 6. BHM stock is expected to pay a dividend of $2.50 a year from now, and its dividends are expected to grow by 6% per year thereafter. What is the price of a BHM share if the market capitalization rate is 7% per year? (a) $250.00 (b) $192.31 (c) $25.00 (d) $19.23 Answer: (c) 7. IOU stock is expected to pay a dividend of $1.67 a year from now, and its dividends are not expected to grow in the foreseeable future. If the market capitalization rate is 7%, what is the current price of a share of IOU stock? (a) $11.69 (b) $23.86 (c) $116.90 (d) $238.60 Answer: (b)
8.GMATS stock is currently selling for $34.50 a share.The current dividend for this stock is $1.60 and dividends are expected to grow at a constant rate of 10%per year thereafter.What must be the market capitalization rate for a share of GMATS stock? (a)4.90% (b)5.36% (c)14.64% (d)15.10% Answer:(d) 9.Avacor stock is expected to pay a dividend of $1.89 a year from now,and its dividends are expected to grow at a constant rate of 5%per year thereafter.If the market capitalization rate is 14%per year,what is the current price of a share of Avacor stock? (a)$13.50 (b)$18.90 (c)$21.00 (d)$37.80 Answer:(c) 10.GRITO stock is currently selling for $46.10 a share.If the company is expected to pay a dividend of $5.60 a year from now and dividends are not expected to grow thereafter,what is the market capitalization rate for a share of GRITO stock? (a)7.56% (b)8.23% (c)10.50% (d)12.15% Answer:(d) 11.In the DDM model,if D and k are held constant,what will happen to the price of a stock if the constant growth rate gets higher? (a)the price of the stock will be higher (b)the price of the stock will hold constant (c)the price of the stock will be lower (d)it cannot be determined from the information given Answer:(a) 9-3
9-3 8. GMATS stock is currently selling for $34.50 a share. The current dividend for this stock is $1.60 and dividends are expected to grow at a constant rate of 10% per year thereafter. What must be the market capitalization rate for a share of GMATS stock? (a) 4.90% (b) 5.36% (c) 14.64% (d) 15.10% Answer: (d) 9. Avacor stock is expected to pay a dividend of $1.89 a year from now, and its dividends are expected to grow at a constant rate of 5% per year thereafter. If the market capitalization rate is 14% per year, what is the current price of a share of Avacor stock? (a) $13.50 (b) $18.90 (c) $21.00 (d) $37.80 Answer: (c) 10. GRITO stock is currently selling for $46.10 a share. If the company is expected to pay a dividend of $5.60 a year from now and dividends are not expected to grow thereafter, what is the market capitalization rate for a share of GRITO stock? (a) 7.56% (b) 8.23% (c) 10.50% (d) 12.15% Answer: (d) 11. In the DDM model, if D1 and k are held constant, what will happen to the price of a stock if the constant growth rate gets higher? (a) the price of the stock will be higher (b) the price of the stock will hold constant (c) the price of the stock will be lower (d) it cannot be determined from the information given Answer: (a)
12.The relation between earnings and dividends in any period is (a)Dividends =Earnings/Net New Investment (b)Dividends=Earnings x Net New Investment (c)Dividends=Earnings Net New Investment (d)Dividends Earnings-Net New Investment Answer:(d) 13.Consider a firm called Nowhere Corporation,whose earnings per share are $12.The firm invests an amount each year that is just sufficient to replace the production capacity that is wearing out,and so the new investment is zero.The firm pays out all its earnings as dividends.Calculate the price of a share of Nowhere Corporation stock,give that k=14%. (a)$168.00 (b)$166.67 (c)$85.71 (d)$82.40 Answer:(c) 14.Consider a firm called SureBet Corporation.SureBet reinvests 55%of its earnings each year into new investments that earn a rate of return of 17%per year.Currently,SureBet Corporation has earnings per share of $12 and pays out 45%or $5.40 as dividends.Calculate the growth rate of earnings and dividends. (a)7.65% (b)8.50% (c)9.35% (d)24.75% Answer:(c) 15.What adds value to the current price of a share of stock is (a)growth per se (b)tax advantages (c)investment opportunities that earn rates of return >k (d)all of the above Answer:(c) 9-4
9-4 12. The relation between earnings and dividends in any period is ________. (a) Dividends = Earnings/Net New Investment (b) Dividends = Earnings x Net New Investment (c) Dividends = Earnings + Net New Investment (d) Dividends = Earnings – Net New Investment Answer: (d) 13. Consider a firm called Nowhere Corporation, whose earnings per share are $12. The firm invests an amount each year that is just sufficient to replace the production capacity that is wearing out, and so the new investment is zero. The firm pays out all its earnings as dividends. Calculate the price of a share of Nowhere Corporation stock, give that k = 14%. (a) $168.00 (b) $166.67 (c) $85.71 (d) $82.40 Answer: (c) 14. Consider a firm called SureBet Corporation. SureBet reinvests 55% of its earnings each year into new investments that earn a rate of return of 17% per year. Currently, SureBet Corporation has earnings per share of $12 and pays out 45% or $5.40 as dividends. Calculate the growth rate of earnings and dividends. (a) 7.65% (b) 8.50% (c) 9.35% (d) 24.75% Answer: (c) 15. What adds value to the current price of a share of stock is ________. (a) growth per se (b) tax advantages (c) investment opportunities that earn rates of return > k (d) all of the above Answer: (c)
16.In order to evaluate the stock of Beltran Inc.,an analyst uses the constant growth discounted dividend model.Expected earnings of $12 per share is assumed,as are an earnings retention rate of 70%and an expected rate of return on future investments of 17%per year.If the market capitalization rate is 14%per year,calculate the price for a share of Beltran stock. (a)$171.43 (b)$367.35 (c)$400.00 (d)$857.14 Answer:(a) 17.In order to evaluate the stock of The Rendell-Vine Corporation,an analyst uses the constant growth discounted dividend model.Expected earnings of $12 per share is assumed,as are an earnings retention rate of 70%and an expected rate of return on future investments of 17% per year.If the market capitalization rate is 14%per year,what is the implied net present value of future investments? (a)$314.29 (b)$281.64 (c)$171.43 (d)$85.72 Answer:(d) 18.In order to evaluate the stock of Toys'R'Me,an analyst uses the constant growth discounted dividend model.Expected earnings of $14 per share is assumed,as are an earnings retention rate of 60%and an expected rate of return on future investments of 17%per year.If the market capitalization rate is 15%per year,what is the implied net present value of future investments? (a)$23.34 (b)$70.00 (c)$93.34 (d)$116.67 Answer:(a) 19.Firms with consistently high P/E multiples are interpreted to have either relatively market capitalization rates or relatively present value of value-added investments. (a)low;low (b)high;high (c)high;low (d)low;high Answer:(d) 9-5
9-5 16. In order to evaluate the stock of Beltran Inc., an analyst uses the constant growth discounted dividend model. Expected earnings of $12 per share is assumed, as are an earnings retention rate of 70% and an expected rate of return on future investments of 17% per year. If the market capitalization rate is 14% per year, calculate the price for a share of Beltran stock. (a) $171.43 (b) $367.35 (c) $400.00 (d) $857.14 Answer: (a) 17. In order to evaluate the stock of The Rendell-Vine Corporation, an analyst uses the constant growth discounted dividend model. Expected earnings of $12 per share is assumed, as are an earnings retention rate of 70% and an expected rate of return on future investments of 17% per year. If the market capitalization rate is 14% per year, what is the implied net present value of future investments? (a) $314.29 (b) $281.64 (c) $171.43 (d) $85.72 Answer: (d) 18. In order to evaluate the stock of Toys’R’Me, an analyst uses the constant growth discounted dividend model. Expected earnings of $14 per share is assumed, as are an earnings retention rate of 60% and an expected rate of return on future investments of 17% per year. If the market capitalization rate is 15% per year, what is the implied net present value of future investments? (a) $23.34 (b) $70.00 (c) $93.34 (d) $116.67 Answer: (a) 19. Firms with consistently high P/E multiples are interpreted to have either relatively ________ market capitalization rates or relatively ________ present value of value-added investments. (a) low; low (b) high; high (c) high; low (d) low; high Answer: (d)