40) In response to the stock market’s reaction to its dividend policy, the Nico’s Toy Company has
decided to increase its dividend payment at a rate of 4 percent per year. The firm’s most recent
dividend is $3.25 and the required rate of interest is 9 percent. What is the maximum you would
be willing to pay for a share of the stock?
41) Uncle Tim’s Inventions has an expected dividend next year of $3.60 and a required return of
12 percent. Assuming the same dividend will be paid indefinitely, calculate the value of a share
of common stock assuming a zero growth rate of dividends.
42) Ria’s Doll Company has an outstanding preferred issue of stock with a par value of $100 and
an annual dividend of 10 percent (of par). Similar risk preferred stocks are yielding an 11.5
percent annual rate of return.
(a) What is the current value of the outstanding preferred stock?
(b) What will happen to price if the risk-free rate increases? Explain.
43) Ted has 10 shares of Grand Company. Based on the company’s dividend policy, Ted will
receive a total of $450 a year in perpetuity. What is the value of each share if the appropriate
discount rate is 8 percent?
44) The Bradshaw Company’s most recent dividend was $6.75. The historical dividend payment
by the company shows a constant growth rate of 5 percent per year. What is the maximum you
would be willing to pay for a share of its common stock if your required rate of return is 8
percent?
45) Tina’s Medical Equipment Company paid a $2.25 common stock dividend last year. The
company’s policy is to allow its dividend to grow at 5 percent per year indefinitely. What is the
value of the stock if the required rate of return is 8 percent?
46) Angel recently purchased a block of 100 shares of Hayley’s Optical common stock for
$6,000. She expects to receive annual dividends of $400 indefinitely from those shares.
Assuming a discount rate of 8 percent, how does the price Angel paid compare to the value of
the stock?
47) The Oxford Heating Company has been very successful in the past four years. Over these
years, it paid common stock dividend of $4 in the first year, $4.20 in the second year, $4.41 in
the third year, and its most recent dividend was $4.63. The company wishes to continue this
dividend growth indefinitely. What is the value of the company’s stock if the required rate of
return is 12 percent?
48) Xiao Xin owns stock in a company which has paid the annual dividends shown in Table 7.1.
Calculate the growth rate of these dividends.
49) Calculate the estimated dividend for 2020. (See Table 7.1)
50) The required return is 17 percent. Using the Gordon model, calculate the per share value of
the stock for 2020 (assume the 2020 dividend comes at the end of the year and you want the
value of the stock at the beginning of the year). (See Table 7.1)
51) Julie’s X-Ray Company paid $2.00 per share in common stock dividends last year. The
company will allow its dividend to grow at 5 percent for 4 years, and after that the rate of growth
will be 3 percent forever. What is the value of the stock if the required rate of return is 8 percent?
52) Compute the value of a share of common stock of Lexi’s Cookie Company whose most
recent dividend was $2.50 and is expected to grow at 3 percent per year for the next 5 years, after
which the dividend growth rate will increase to 6 percent per year indefinitely. Assume a 10
percent required rate of return.
53) Patrick Company expects to generate free cash flow of $120,000 per year forever. If the
firm’s required return is 12 percent, the market value of debt is $300,000, the market value of
preferred stock is $70,000, and the company has 100,000 shares of stock outstanding. What is
the value of Patrick’s stock?
A) $6.30
B) $10.00
C) $7.00
D) $9.70
54) The free cash flow valuation model can be used to determine the value of an entire company
as the present value of its expected free cash flows discounted at the firm’s weighted average cost
of capital.
55) The free cash flow valuation model is based on the same principle as the P/E valuation
approach; that is, the value of a share of stock is the present value of future cash flows.
56) The free cash flow valuation model is based on the same principle as dividend valuation
models; that is, the value of a share of stock is the present value of future cash flows.
57) In valuation of common stock, the price/earnings multiple approach usually produces higher
valuations than the book or liquidation values since it considers expected earnings.
58) The common stock book value model ignores a firm’s expected earnings potential and
generally lacks any true relationship to the firm’s value in the marketplace.
59) The liquidation value per share of common stock is the amount per share of common stock
that would be received if all of a firm’s assets were sold for their accounting value and the
proceeds remaining were divided among common stockholders.
60) The book value per share of common stock is the amount per share of common stock that
would be received if all of a firm’s assets were sold for their accounting value and the proceeds
remaining were divided among common stockholders.
61) Ted Corporation expects to generate free-cash flows of $200,000 per year for the next five
years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per
year forever. If the firm’s weighted average cost of capital is 15 percent, the market value of the
firm’s debt is $500,000, and Ted has a half million shares of stock outstanding, what is the value
of Ted stock?
A) $2.43
B) $3.43
C) $1.43
D) $0.00
62) ________ is the value of a firm’s ownership in the event that all assets are sold for their exact
accounting value and the proceeds remaining after paying all liabilities (including preferred
stock) are divided among common stockholders.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the common stock
63) ________ is the actual amount each common stockholder would expect to receive if a firm’s
assets are sold for their market value, creditors and preferred stockholders are repaid, and any
remaining money is divided among the common stockholders.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
64) ________ is a guide to a firm’s value if it is assumed that investors value the earnings of a
given firm in the same way they do the average firm in the industry.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
65) Which of the following valuation methods tends to value stocks more highly than the others
in the list because it considers expected earnings?
A) liquidation value
B) book value
C) P/E multiple
D) present value of the interest
66) The use of the ________ is especially helpful in valuing firms that are not publicly traded.
A) liquidation value
B) book value
C) P/E multiple
D) present value of the dividends
67) The current price of DEF Corporation stock is $26.50 per share. Earnings next year should
be $2 per share and it should pay a $1 dividend. The P/E multiple is 15 times on average. What
price would you expect for DEF’s stock in the future?
A) $13.50
B) $15.00
C) $26.50
D) $30.00
68) At year end, the Tangshan China Company balance sheet showed total assets of $60 million,
total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock
outstanding. Based on this information, Tangshan’s book value per share of common stock is
________.
A) $105
B) $10.50
C) $15
D) $150
69) At year end, Tangshan China Company balance sheet showed total assets of $60 million,
total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock
outstanding. If Tangshan could sell its assets for $52.5 million, Tangshan’s liquidation value per
share of common stock is ________.
A) $15
B) $7.50
C) $52.50
D) $75
70) At year end, Tangshan China Company balance sheet showed total assets of $60 million,
total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock
outstanding. Next year, Tangshan is projecting that it will have net income of $1.5 million. If the
average P/E multiple in Tangshan’s industry is 15, what should be the price of Tangshan’s stock?
A) $15.00
B) $22.50
C) $52.50
D) $75.00
71) China Imports currently has 2,000 shares of common stock outstanding. The firm has assets
of $200,000 and total liabilities including preferred stock of $75,000. Calculate the book value
per share of China Imports common stock.
72) Based on analysis of the company and expected industry and economic conditions, China
Imports is expected to earn $4.60 per share of common stock next year. The average
price/earnings ratio for firms in the same industry is 8. Calculate the estimated value of a share of
China Imports common stock.
73) Due to growing demand for computer software, the Shine Company has had a very
successful year and expects its earnings per share to grow by 25 percent to reach $5.50 for this
year. Estimate the price of the company’s common stock assuming the industry’s price/earning
ratio is 12.
74) Karina’s Caribbean Foods had total assets as recorded on its balance sheet of $1,500,000.
What is the book value of the Karina’s common stock if it has $950,000 in liabilities, and 7,500
shares of common stock outstanding?
75) Ride World has estimated the market value of its assets to be $1,250,000. What is the value
of Ride World’s common stock if it has $900,000 in liabilities, $50,000 in preferred stock, and
7,500 shares of common stock outstanding?
76) Smith, Inc. stock currently sells for $75 per share. The firm has total assets of $1,000,000
and total liabilities, including preferred stock, of $350,000. If the firm has 10,000 shares of
common stock outstanding,
(a) what is the book value of each share of common stock?
(b) relative to book value, is the stock overvalued or undervalued in the marketplace?
(c) what is the reason(s) for your answer in (b)?
77) Smith has current assets of $800,000, which can be liquidated at 90 percent of book value.
Total liabilities, including preferred stock, equal $270,000. The firm has 15,000 shares of
common stock outstanding. What is the liquidation value per share of common stock?
48
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7.4 Decision making and common stock value
1) Any action taken by a financial manager that increases risk will also increase the required
return.
2) An action on the part of a firm that increases the level of expected cash flows without a
corresponding increase in risk should reduce share value; an action that reduces the level of
expected cash flows without a corresponding decline in risk should increase share value.
3) Assuming that economic conditions remain stable, any management action that would cause
current and prospective stockholders to raise their dividend expectations should decrease a firm’s
value.
4) The required return can be affected by changes in the risk free rate, even if the risk premium
remains constant.
5) If the risk-free rate decreases due to a shift in government policy, the required return goes up.
6) Milton Glasses recently paid a dividend of $1.70 per share, is currently expected to grow at a
constant rate of 5%, and has a required return of 11%. Milton Glasses has been approached to
buy a new company. Milton estimates if it buys the company, its constant growth rate would
increase to 6.5%, but the firm would also be riskier, therefore increasing the required return of
the company to 12%. Should Milton go ahead with the purchase of the new company?
A) Yes, because the value of the Milton Co. will increase by $3.17 per share
B) Yes, because the value of the Milton Co. will increase by $2.56 per share
C) Yes, because the value of the Milton Co. will increase by $4.59 per share
D) No, because the value of the Milton Co. will decrease by $3.17 per share