978-0134083308 Chapter 8 Part 2

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5) Both beta and the expected return on the market portfolio incorporate risk into the Capital

Asset Pricing Model.

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6) The required rate of return denotes the minimum rate of return an investor should expect.

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7) The intrinsic value of an asset equals the present value of all future cash flows at a given

discount rate.

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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.

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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%

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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

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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

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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

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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.

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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.

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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

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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.

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17) Explain how the time value of money concept is used in stock valuation.

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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.

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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).

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3) If the annual dividend on a stock never changes, its price will never change.

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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.

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5) The dividend valuation model estimates the value of a share of stock as the future value of

all dividends.

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6) The growth rate of dividends cannot be permanently greater than the required rate of return.

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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.

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8) The intrinsic value of a zero-growth stock can be found simply by dividing the dividend by

the required rate of return.

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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.

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10) The rate of dividend growth can be estimated by multiplying the return on equity rate by

the dividend payout ratio.

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11) The rate of growth can exceed the required return during the variable-growth period

without invalidating the variable growth dividend valuation model.

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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

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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.

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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.

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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.

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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.

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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.

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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

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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

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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.

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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%

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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.

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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

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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%

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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%

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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.

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