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1. Which of the following
statements is CORRECT?
a. The constant growth model
takes into consideration the capital gains investors expect to earn on a stock.
b. Two firms with the same
expected dividend and growth rates must also have the same stock price.
c. It is appropriate to use the
constant growth model to estimate a stock's value even if its growth rate is
never expected to become constant.
d. If a stock has a required rate
of return rs = 12%, and if its dividend is expected to grow at a constant rate
of 5%, this implies that the stock’s dividend yield is also 5%.
e. The price of a stock is the
present value of all expected future dividends, discounted at the dividend
growth rate.
2. Stocks A and B have the following data.
Assuming the stock market is efficient and the stocks are in equilibrium, which
of the following statements is CORRECT?
A B
Price
$25 $25
Expected growth (constant) 10% 5%
Required return 15% 15%
a. Stock A's expected dividend at
t = 1 is only half that of Stock B.
b. Stock A has a higher dividend
yield than Stock B.
c. Currently the two stocks have
the same price, but over time Stock B's price will pass that of A.
d. Since Stock A’s growth rate is
twice that of Stock B, Stock A’s future dividends will always be twice as high
as Stock B’s.
e. The two stocks should not sell
at the same price. If their prices are equal, then a disequilibrium must exist.
3. Which of the following
statements is CORRECT?
a. A major disadvantage of
financing with preferred stock is that preferred stockholders typically have
supernormal voting rights.
b. Preferred stock is normally
expected to provide steadier, more reliable income to investors than the same
firm’s common stock, and, as a result, the expected after-tax yield on the
preferred is lower than the after-tax expected return on the common stock.
c. The preemptive right is a
provision in all corporate charters that gives preferred stockholders the right
to purchase (on a pro rata basis) new issues of preferred stock.
d. One of the disadvantages to a
corporation of owning preferred stock is that 70% of the dividends received
represent taxable income to the corporate recipient, whereas interest income
earned on bonds would be tax free.
e. One of the advantages to
financing with preferred stock is that 70% of the dividends paid out are tax
deductible to the issuer.
4. Church Inc. is presently
enjoying relatively high growth because of a surge in the demand for its new
product. Management expects earnings and dividends to grow at a rate of 25% for
the next 4 years, after which competition will probably reduce the growth rate
in earnings and dividends to zero, i.e., g = 0. The company’s last dividend,
D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the
risk-free rate is 3.00%. What is the current price of the common stock?
a. $26.77
b. $27.89
c. $29.05
d. $30.21
e. $31.42
5. Your boss, Sally Maloney,
treasurer of Fred Clark Enterprises (FCE), asked you to help her estimate the
intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and
the stock now sells for $15.00 per share. Sally asked a number of security
analysts what they believe FCE's future dividends will be, based on their
analysis of the company. The consensus is that the dividend will be increased
by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year
in Year 4 and thereafter. Sally asked you to use that information to estimate
the required rate of return on the stock, rs, and she provided you with the
following template for use in the analysis.
Sally told you that the growth
rates in the template were just put in as a trial, and that you must replace
them with the analysts' forecasted rates to get the correct forecasted
dividends and then the estimated TV. She also notes that the estimated value
for rs, at the top of the template, is also just a guess, and you must replace
it with a value that will cause the Calculated Price shown at the bottom to
equal the Actual Market Price. She suggests that, after you have put in the
correct dividends, you can manually calculate the price, using a series of
guesses as to the Estimated rs. The value of rs that causes the calculated
price to equal the actual price is the correct one. She notes, though, that
this trial-and-error process would be quite tedious, and that the correct rs
could be found much faster with a simple Excel model, especially if you use
Goal Seek. What is the value of rs?
a. 11.84%
b. 12.21%
c. 12.58%
d. 12.97%
e. 13.36%
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