978-0134083308 Chapter 8 Part 3

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27) In applying the variable-growth dividend valuation model to a company’s stock, analysts

frequently define the growth rate, g, as equal to

A) ROE multiplied by the firm’s retention rate.

B) ROE divided by the dividend payout ratio.

C) the dividend payout ratio multiplied by the firm’s retention rate.

D) P/E multiplied by the dividend payout ratio.

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28) A company has an annual dividend growth rate of 5% and a retention rate of 40%. The

company’s dividend payout ratio is

A) 35%.

B) 40%.

C) 45%.

D) 60%.

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29) Which of the following statements concerning the constant-growth dividend valuation

model is (are) correct?

I. One simple method of estimating the dividend growth rate is to analyze the historical

pattern of dividends.

II. The expected total return equals the return from capital gains plus the return from dividends

paid.

III. The model is applicable to growth firms with initially high growth rates.

IV. The intrinsic value calculated using this method can change from one investor to another if

their risk-return payoffs differ.

A) I and IV only

B) II and III only

C) I, II and IV only

D) I, II and III only

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30) The variable-growth dividend valuation model

A) develops the value of a stock using the future value of dividends minus a rate of capital gain

growth.

B) is valuable because it accounts for the general growth patterns of most companies.

C) is invalid if at any point in time the growth rate exceeds the required rate of return.

D) assumes the rate of dividend growth will vary indefinitely.

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31) In general, the higher the retention ratio

A) the higher the future growth rate of the company.

B) the higher the dividends per share of common stock.

C) the higher the future debt-equity ratio.

D) the lower the future book value per share.

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32) Martin’s Inc. is expected to pay annual dividends of $2.50 a share for the next three years.

After that, dividends are expected to increase by 3% annually. What is the current value of this

stock to you if you require a 9% rate of return on this investment?

A) $39.47

B) $40.11

C) $41.81

D) $42.92

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33) MBA Inc. will pay a dividend for the first time at the end of 2016. It projects the following

dividend per share:

2016 $1.50

2017 $2.00

2018 $2.50

Beginning with 2016 dividends will grow at 4% per year. The required rate of return is 12%.

The intrinsic value of MBA shares is

A) $25.37.

B) $27.85.

C) $28.96.

D) $38.50.

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34) DMC3 Inc. will pay no dividend for 2016 or 2017. At the end of 2018, it will pay a

dividend of $1.50.

Thereafter dividends will grow at 4% per year. The required rate of return is 10%. The

intrinsic value of DMC3 shares is (assume you are at the beginning of 2016)

A) $34.61.

B) $26.00

C) $24.91.

D) $20.66.

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35) WaterCo is a manufacturer of boat parts and has been in business only a few years. Its

board of directors decided to start paying a dividend to help boost the attractiveness of its stock.

The dividend will be $0.50 per share next year. After that dividends will increase by 4 percent

per year. The company has a beta of 1.6. The market rate of return is 8% and the T-bill rate is

3%. Should you purchase shares in this firm at the current market price of $6.98 per share?

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36) The common stock of Peachtree Paper, Inc., is currently selling for $40 a share. A dividend

of $2.00 per share was just paid. You are estimating that this dividend will grow at a constant

rate of 10%.

(a) Using the constant growth DVM model, what is your required rate of return if $40 is a

reasonable trading price? (Show all work.)

(b) If Peachtree Papers is a new company that produces a relatively unknown product, is the

constant growth model a good valuation method for a potential investor to use? Justify your

answer.

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8.5 Learning Goal 5

1) A stock’s internal rate of return (IRR) is the discount rate that cause the present value of

future dividends and the price at which a stock is expected to be sold to equal the current price

of the stock.

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2) Neither the P/E approach nor the cash flow to equity approach rely on dividends as the key

input into the valuation of a stock.

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3) The free cash flow to equity approach does not require that a stock pay dividends.

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4) The investor’s internal rate of return is always equal to the firm’s rate of return on equity.

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5) The value of a stock using the price to cash flow approach is to multiply the P/E ratio times

operating cash flow divided by the number of shares outstanding.

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6) High price/sales multiples often go with high profit margins.

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7) Stocks trading at high price to book value multiples may be especially attractive to bargain

hunters.

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8) Which of the following statements concerning the Price to Cash-Flow approach to stock

valuation are true?

I. The Price to Cash-Flow method works just as well for non-dividend paying stocks as it does

for dividend-paying stocks.

II. The Price to Cash-Flow calculate s the intrinsic value of a stock as the present value of

future cash flows.

III. The Price to Cash-Flow ratio divides the market price of one share of stock by cash flow

per share.

IV. The Price to Cash-Flow method does not directly calculate the intrinsic value of a share.

A) I and II only

B) III and IV only

C) I, III and IV only

D) I, II and III only

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9) Commonly used multiples for determining a stock’s value include

I. price to earnings.

II. price to sales.

III. price to cash flow.

IV. price to dividends.

A) I, II and III only

B) I, III and IV only

C) II, III and IV only

D) I, II, III and IV

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10) The intrinsic value of a stock is greater than its current market price if

A) The market price is higher than the present value of expected future cash flows.

B) the stock’s P/E ratio is higher than the market’s average P/E ratio.

C) the stock’s IRR exceeds the required rate of return.

D) the stock’s P/CF ratio is higher than the market’s average P/CF ratio.

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11) Zephyr Inc. sells wind based systems for generating electricity. The company pays no

dividends, but you estimate the stock will be worth $50 per share 5 years from now and you

require a 15% rate of return for stock investments of this type. What price should you be

willing to pay for this stock?

A) $12.50

B) $24.86

C) $43.48

D) $57.50

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12) Ivonne has bought shares of RIO, Inc. stock for $25.00 per share. She expects a 1.00

dividend at the end of this year. After 2 years, she expects to receive a dividend of $1.25 and to

sell the stock for $28.75. What is Ivonne’s required rate of return?

A) 4.0%

B) 11.6%

C) 15.2%

D) 24.0%

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