978-0132757089 Chapter 10 Part 2

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33) A share of common stock just paid a dividend of $3.25 per share. The expected long-run

growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the

price of the stock be?

A) $57.51

B) $62.25

C) $71.86

D) $63.92

E) $44.94

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

34) Common stockholders expect greater returns than bondholders because:

A) they have no legal right to receive dividends.

B) they bear greater risk.

C) in the event of liquidation, they are only entitled to receive any cash that is left after all

creditors are paid.

D) all of the above.

Topic: 10.1 Common Stock

Keywords: NYSE

Principles: Principle 2: There Is a Risk-Return Tradeoff

35) WSU Inc. is a young company that does not yet pay a dividend. You believe that the

company will begin to pay dividends 5 years from now, and that the company will then be worth

$50 per share. If your required rate of return on this risky stock is 20%, what is the stock worth

today?

A) $40

B) $10

C) $20.09

D) $0.00

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

36) Common stockholders are essentially creditors of the firm.

Topic: 10.1 Common Stock

Keywords: market required yield

Principles: Principle 2: There Is a Risk-Return Tradeoff

37) Common stock represents a claim on residual income.

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

38) The growth rate of future earnings is determined by return on equity and the profit-retention

rate.

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

39) The stockholder’s expected rate of return consists of a dividend yield and interest.

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

40) When bankruptcy occurs, the claims of the common shareholders may go unsatisfied.

Topic: 10.1 Common Stock

Keywords: NYSE

Principles: Principle 2: There Is a Risk-Return Tradeoff

41) Cumulative voting gives each share of stock a number of votes equal to the number of

directors being elected to the board.

Topic: 10.1 Common Stock

Keywords: voting rights

Principles: Principle 4: Market Prices Reflect Information

42) The expected rate of return implied by a given market price equals the required rate of return

for investors at the margin.

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

43) Stock valuation is more precise than bond valuation as stock cash flows are more certain.

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

44) The stock valuation model D1/(Rc – g) requires Rc > G.

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

45) Is the following common stock priced correctly? If no, what is the correct price?

Price = $26.25

Required rate of return = 13%

Dividend year 0 = $2.00

Dividend year 1 = $2.10

2.00 – 10.2

47) Tannerly Worldwide’s common stock is currently selling for $48 a share. If the expected

dividend at the end of the year is $2.40 and last year’s dividend was $2.00, what is the rate of

return implicit in the current stock price?

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

48) Draper Company’s common stock paid a dividend last year of $3.70. You believe that the

long-term growth in the dividends of the firm will be 8% per year. If your required return for

Draper is 14%, how much are you willing to pay for the stock?

.08) (70.3$ 

996.3$

51) You can purchase one share of Sumter Company common stock for $80 today. You expect

the price of the common stock to increase to $85 per share in one year. The company pays an

annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?

00.3$

00.85$

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

5) The retail analyst at Morgan-Sachs values stock of the GAP at $28.00 per share. They are

using the average industry P/E ratio of 15. Their forecasted earnings per share for next year is:

A) $0.54.

B) $1.50.

C) $1.87.

D) There is not enough information calculate earnings per share.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

6) Home Depot stock is currently selling for $30 per share. Next year’s dividend is expected to

be $1.00; next year’s earnings per share are expected to be $2.14. Home Depot’s P/E ratio is:

A) .07.

B) 14.

C) 2.14.

D) 30.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

7) McDonald’s stock currently sells for $77.50. It’s expected earnings per share are $4.50. The

average P/E ratio for the industry is 23.3. If investors expected the same growth rate and risk for

McDonald’s as for an average firm in the same industry, it’s stock price would:

A) stay about the same.

B) rise.

C) fall.

D) there is not enough information.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

8) If the ROE on a new investment is less than the firm’s required rate of return:

A) the investment increases the firm’s value.

B) the investment leaves the firm’s value unchanged.

C) the effect on the firm’s value is unpredictable.

D) the investment reduces the firm’s value.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

9) Zorba’s is a small chain of of restaurants whose stock is not publicly traded. The average P/E

ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year’s

earnings were $1.10 per share; next’s earnings are expected to be $1.21 per share. A reasonable

price for a share of Zorba’s stock is:

A) $19.97.

B) $18.15.

C) $20.23.

D) $16.72.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

23.72 and the P/E ratio based on expected earnings is 17.48. The expected growth rate in Apples

earnings must be:

A) -26%.

B) 36%.

C) 7.6%.

D) 5.5%.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

11) The P/E ratio is the market price of a share of stock divided by book equity per share.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

12) The higher a firm’s P/E ratio, the more optimistic investors’ feel about the firm’s growth

prospects.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

13) P/E ratios found in published sources or on the internet are always computed by dividing the

next period’s expected earnings into the current price of the stock.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

14) The higher the investor’s required rate of return, the higher the P/E ratio will be.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

15) Walmart’s current earnings per share of $4.39 are expected to grow at a rate of 12% per year

for the next few years. Using a P/E ratio fo 12.5, what is a reasonable value for a share of

Walmart Stock.

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

15.7, and 16.5. RAH’s current earnings per share are $1.50. They are expected to grow at 6% for

the next few years. What is a reasonable price for a share of RAH stock?

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

1) UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%,

how much will you be willing to pay for one share?

A) $38.46

B) $26.26

C) $65.46

D) $46.38

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

2) Green Corp.’s preferred stock is selling for $20.83. If the company pays $2.50 annual

dividends, what is the expected rate of return on its stock?

A) 8.33%

B) 12.00%

C) 2.50%

D) 20.00%

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

3) Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The

preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on

this stock. What is the value of the preferred stock today? Round to the nearest $1.

A) $100

B) $85

C) $75

D) $16

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

4) Which of the following statements is true?

A) Preferred stockholders are entitled to dividends before common stockholders can receive

dividends.

B) Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay

back the investment.

C) The market value of preferred stock, like bonds, will usually fluctuate in value primarily as

the result of market rates of interest.

D) All of the above.

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

5) Which of the following statements concerning preferred stock is correct?

A) Preferred stock generally is more costly to the firm than common stock.

B) Most issues of preferred stock have a cumulative feature.

C) Preferred dividend payments are tax-deductible.

D) Preferred stock is a riskier form of capital to the firm than bonds.

Topic: 10.3 Preferred Stock

Keywords: cumulative preferred

Principles: Principle 3: Cash Flows Are the Source of Value