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11
5) Both beta and the expected return on the market portfolio incorporate risk into the Capital
Asset Pricing Model.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
6) The required rate of return denotes the minimum rate of return an investor should expect.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
7) The intrinsic value of an asset equals the present value of all future cash flows at a given
discount rate.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
8) The intrinsic value of a stock provides a purchase price for the stock
A) that is reasonable given the associated level of risk.
B) which will assuredly yield the anticipated capital gain.
C) which will guarantee the expected rate of return.
D) that is always below the market value but yet yields the expected rate of return.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
9) The risk-free rate of return is 2.2 percent, the expected market return is 11 percent, and the
beta for Solstice, Inc. is 1.12. What is Solstice's required rate of return?
A) 8.80%
B) 12.05%
C) 13.20%
D) 14.30%
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
12
10) The risk free rate is 2%. The expected rate of return on the market is 12%. Beta and the
expected rate of return for four stocks are as follows.: ABC .8 , 10%; DEF 1, 12%; GHI 1.2 ,
13%, and JKL 2, 22%. Which of these stocks should not be purchased?
A) ABC
B) DEF
C) GHI
D) JKL
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
11) Which of the following are key inputs to determining the intrinsic value of an asset?
I. the required rate of return
II. future cash flows
III. current stock price
IV. timing of future cash flows
A) I and II only
B) I and III only
C) I, II and IV only
D) II, III and IV only
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
12) In the Capital Asset Pricing Model, which of the following factors are used to determine the
required rate of return?
I. the risk-free interest rate
II. future cash flows
III. expected return on the market portfolio
IV. beta
A) I and II only
B) I, II and III only
C) II, III and IV only
D) I, III and IV only
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
13
13) The most uncertain value used in the Capital Asset Pricing Model is
A) beta.
B) the risk-free rate.
C) expected return on the market.
D) all are equally uncertain.
AACSB: 3 Analytical thinking
Question Status: New Question
Learning Goal: Learning Goal 3
14) An investor should purchase a stock when
A) the market price exceeds the intrinsic value.
B) the expected rate of return equals or exceeds the required return.
C) the capital gains rate is less than the required return and no dividends are paid.
D) the market price is greater than the justified price.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
15) Which of the following variables used in determining a stock's intrinsic value can be known
with the greatest level of confidence?
A) future earnings
B) expected return on the market
C) the risk free rate of return
D) future dividends
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
16) Heather believes that by carefully examining a company's fundamentals and by applying
the best valuation models she can identify stocks whose market prices are lower than their
intrinsic values. In order for this to be true
A) she needs an accurate estimate of future earnings and dividends.
B) some stocks must be incorrectly priced.
C) betas must be stable over time.
D) P/E ratios for both the stock and the market must be stable over time.
AACSB: 3 Analytical thinking
Question Status: New Question
Learning Goal: Learning Goal 3
14
17) Explain how the time value of money concept is used in stock valuation.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 3
8.4 Learning Goal 4
1) The required rate of return estimated by the Capital Asset Pricing Model is not suitable for
use in dividend valuation models.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
2) The approach to stock valuation which holds that the value of a share of stock is a function
of its future dividends is known as the dividend valuation model (DVM).
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
3) If the annual dividend on a stock never changes, its price will never change.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
4) The dividend valuation model (DVM) is very sensitive to the growth rate (g) being used,
because it affects both the model's numerator and its denominator.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
15
5) The dividend valuation model estimates the value of a share of stock as the future value of
all dividends.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
6) The growth rate of dividends cannot be permanently greater than the required rate of return.
AACSB: 3 Analytical thinking
Question Status: New Question
Learning Goal: Learning Goal 4
7) One of the easiest aspects of the dividend valuation model (DVM) is specifying the
appropriate growth rate for a firm's dividends over time.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
8) The intrinsic value of a zero-growth stock can be found simply by dividing the dividend by
the required rate of return.
AACSB: 3 Analytical thinking
Question Status: Revised
Learning Goal: Learning Goal 4
9) One method of estimating the dividend growth rate is to calculate the discount rate that
equates today's dividend with the dividend paid several years ago.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
10) The rate of dividend growth can be estimated by multiplying the return on equity rate by
the dividend payout ratio.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
16
11) The rate of growth can exceed the required return during the variable-growth period
without invalidating the variable growth dividend valuation model.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
12) The dividend valuation model (DVM) cannot accommodate which of the following
assumptions?
A) constant dividends
B) a constant growth rate of dividends less than the required rate of return
C) a constant growth rate of dividends greater than the required rate of return
D) dividends growing at a variable rate
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
13) Lindor Inc.'s $100 par value preferred stock pays a dividend fixed at 8% of par. To earn
12% on an investment in this stock, you need to purchase the shares at a per share price of
A) $9.60.
B) $66.67.
C) $96.00.
D) $150.00.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
14) The required rate of return necessary for the dividend valuation model can be estimated
using
A) the Capital Asset Pricing Model.
B) comparisons to the rates of return on stocks of similar risk.
C) a subjective assessment of the return required over and above less risky investments such as
government bonds.
D) any or all of the above.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
17
15) James is willing to settle for a 10% rate of return on EG stock at a time when investors, on
average, are requiring an 11% rate of return on the same stock. Which of the following will
happen?
A) James will be have to pay more for the stock than he was willing to pay.
B) Investors with different required rates of return will pay different prices for the stock.
C) James will not be able to buy the stock unless the price changes.
D) James will be happy to buy the stock for less than he was willing to pay.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
16) John requires a 12% rate of return on EG stock at a time when investors, on average, are
requiring an 11% rate of return on the same stock. Which of the following will happen?
A) John will have to pay more for the stock than he was willing to pay.
B) Investors with different required rates of return will pay different prices for the stock.
C) John will not be able to buy the stock unless the price changes.
D) John will buy the stock at a lower price.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
17) A company that wants to maintain both a constant growth rate in dividends and a constant
payout ratio will have to
A) grow earnings faster than dividends.
B) increase assets at the same rate as dividends.
C) grow earnings at the same rate as dividends.
D) increase stockholders' equity at the same rate as dividends.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
18
18) Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend
of $3.00 per share. This dividend has remained constant over the past few years and is expected
to remain constant for some time to come. If you want to earn 11% on an investment in the
common stock of Michelak's, how much should you pay to purchase each share of stock?
A) $12.50
B) $18.88
C) $20.83
D) $27.27
AACSB: 3 Analytical thinking
Question Status: New Question
Learning Goal: Learning Goal 4
19) Walpurg, Inc. paid $1.30 as an annual dividend per share last year. The company is
expected to increase their annual dividends by 6% each year. How much should you pay to
purchase one share of this stock if you require a 9% rate of return on this investment?
A) $45.93
B) $11.44
C) $23.39
D) $22.96
AACSB: 3 Analytical thinking
Question Status: New Question
Learning Goal: Learning Goal 4
20) One stock valuation model holds that the value of a share of stock is a function of its future
dividends, and that the dividends will increase at an annual rate which will remain unchanged
over time. This stock valuation model is known as the
A) approximate yield model.
B) holding period return model.
C) dividend reinvestment model.
D) constant growth dividend valuation model.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
19
21) What is the required rate of return on a common stock that is expected to pay a $0.75
annual dividend next year if dividends are expected to grow at 2 percent annually and the
current stock price is $8.59?
A) 8.73%
B) 8.91%
C) 10.73%
D) 11.38%
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
22) The constant-growth dividend valuation model is best suited for use with
A) stocks of new or emerging companies.
B) small-cap stocks within growing industries.
C) the stocks of mature, dividend-paying companies.
D) the stocks of cyclical companies.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
23) When using the constant-growth dividend valuation model, which of the following will
lower the value of the stock?
A) an increase in the required rate of return
B) a decrease in the required rate of return
C) an increase in the dividend payout ratio
D) an increase in the growth rate of the dividends
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
20
24) Newton, Inc. just paid an annual dividend of $0.95. Their dividends are expected to
increase by 4% annually. Newton Company stock is selling for $11.54 a share. What is the
required rate of return on this stock implied by the dividend-growth model?
A) 8.23%
B) 12.2%
C) 12.6%
D) 13.9%
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
25) The Hopkinton Company just paid $2.25 as its annual dividend. The dividends have been
increasing at a rate of 5% annually and this trend is expected to continue. The stock is currently
selling for $63.60 a share. What is the rate of return on this stock?
A) 3.60%
B) 3.70%
C) 8.7%
D) 11.8%
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
26) ABC Company stock currently has a market value equivalent to its intrinsic value. Marco
perceives that ABC Company is increasing its level of risk and therefore Marco increases his
required rate of return on ABC stock. This change in the required rate of return
A) will reduce the intrinsic value of ABC stock to Marco.
B) will increase the intrinsic value of ABC stock to Marco.
C) will change the intrinsic value but the direction of the change cannot be determined.
D) is a signal to Marco that he should buy more ABC Company stock.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 4
