A) $6.46
B) $6.92
C) $9.23
D) $10.15
Answer: C
Explanation: C) P0 = $1.20 / (0.16 – 0.03) = $9.23
Dif: 1 Var: 50+
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
19) Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that
this dividend will grow by 5% per year each year in the future. What will be the current
value of a single share of Spacefood’s stock if the irm’s equity cost of capital is 12%?
A) $24.00
B) $22.29
C) $30.86
D) $34.29
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
20) Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that
this dividend will grow by 4% per year each year in the future. The current price of
Gremlin’s stock is $23.50 per share. What is Gremlin’s equity cost of capital?
A) 11%
B) 12%
C) 14%
D) 16%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
19
21) A company has stock which costs $41.50 per share and pays a dividend of $2.50 per
share this year. The company’s cost of equity is 7%. What is the expected annual growth
rate of the company’s dividends?
A) 0.98%
B) 1.96%
C) 2.94%
D) 3.92%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
22) Which of the following will NOT increase a company’s dividend payments?
A) It can issue more shares.
B) It can increase its earnings.
C) It can decrease the number of shares outstanding.
D) It can increase its dividend payout rate.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
23) Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in
the coming year. It decides to retain 10% of these earnings in order to lease new aircraft.
The return on this investment will be 25%. If its equity cost of capital is 11%, what is the
expected share price of Jumbo Transport?
A) $12.71
B) $14.83
C) $16.94
D) $21.18
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
20
24) Sunnyfax Publishing pays out all its earnings and has a share price of $37. In order to
expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and
reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a
rate of 13%. If the reinvestment does not afect Sunnyfax’s equity cost of capital, what is
the expected share price as a consequence of this decision?
A) $36.67
B) $41.90
C) $52.38
D) $62.86
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
25) Kirkevue Industries pays out all its earnings as dividends and has a share price of $27.
In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to
$1.75 per share and reinvest the retained funds. What is the growth rate that should be
achieved on the reinvested funds to keep the equity cost of capital unchanged?
A) 1.48%
B) 0.14%
C) 0.17%
D) 0.15%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
21
26) Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect
against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the
stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high
growth over the next three years and will reinvest all of its earnings in expanding the
company over this time. Earnings were $1.10 per share before the development of the
vaccine and are expected to grow by 40% per year for the next three years. After this time,
it is expected that growth will drop to 5% and stay there for the expected future. Four
years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of
capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today?
A) $20.62
B) $24.17
C) $33.96
D) $33.51
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
27) What is a major assumption about growth rate in the dividend-discount model?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
28) What is the relationship between the growth rate and the cost of equity implied in the
dividend-discount model?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Revised
22
29) Assuming everything else remains unchanged, how does a irm’s decision to increase
its dividend-payout ratio afect its growth rate?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Previous Edition
30) Can the dividend-discount model handle negative growth rates?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Previous Edition
31) How can the dividend-discount model handle changing growth rates?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Previous Edition
7.5 Limitations of the Dividend-Discount Model
1) Forecasting dividends requires forecasting the irm’s earnings, dividend payout rate, and
future share count.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
2) Stocks that do not pay a dividend must have a value of $0.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
3) Which of the following is a limitation of the dividend-discount model?
A) It cannot handle negative growth rates.
B) It requires accurate dividend forecasts, which is not possible.
C) It requires that the growth rate always be higher than the required rate of return, which
is not realistic.
D) It does not consider past earnings and performance.
23
AACSB Objective: Analytic Skills
Author: WC
Question Status: New
7.6 Share Repurchases and the Total Payout Model
1) Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the
year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends
and 20% used to repurchase shares. If Sultan’s earnings are expected to grow by 5% per
year, these payout rates do not change, and Sultan’s equity cost of capital is 10%, what is
Sultan’s share price?
A) $12.00
B) $24.00
C) $36.00
D) $60.00
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Which of the following models directly values all of the irm’s equity, rather than a single
share?
I. Dividend-discount model
II. Total payout model
III. Discounted cash low model
A) I only
B) II only
C) III only
D) II and III
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Revised
24
3) Valence Electronics has 213 million shares outstanding. It expects earnings at the end of
the year of $800 million. Valence pays out 40% of its earnings in total—15% paid out as
dividends and 25% used to repurchase shares. If Valence’s earnings are expected to grow
by 7% per year, these payout rates do not change, and Valence’s equity cost of capital is
9%, what is Valence’s share price?
A) $11.27
B) $22.54
C) $60.10
D) $75.12
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4) Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the
end of the year to be $960 million. The irm’s equity cost of capital is 9%. Chittenden pays
out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase
shares. If Chittenden’s earnings are expected to grow at a constant 3% per year, what is
Chittenden’s share price?
A) $3.74
B) $2.24
C) $7.47
D) $14.94
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
25
5) Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year
to be $641 million. The irm’s equity cost of capital is 11%. Aaron pays out 50% of its
earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaron’s
earnings are expected to grow at a constant 7% per year, what is Aaron’s share price?
A) $12.48
B) $24.96
C) $37.44
D) $49.92
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
26