18) When estimating the annual growth rate of a dividend stream, we can use a short-cut to
determining the average growth rate by ________.
A) using just the first dividend in the stream and the time-value of money equation
B) using just the last dividend in the stream and the time-value of money equation
C) using the first and last dividend in the stream and the time-value of money equation
D) using the first and last dividend in the stream and the future value interest factor
19) You are examining a firm with a stream of past dividends where the initial dividend is $1.32
and the most recent dividend is $1.96. The number of years between these two dividends (n) is 6
years. What is the average annual dividend growth rate during this six-year period? Use a
calculator to determine your answer.
A) 4.74%
B) 5.35%
C) 6.81%
D) 7.35%
20) For the CloudB&B Company Inc., a stream of past dividends includes an initial dividend is
$1.20 and the most recent dividend of $1.80. The number of years between these two dividends
(n) is 8 years. What is the average annual growth rate of dividends during this eight-year period?
Use a calculator to determine your answer.
A) 5.00%
B) 5.20%
C) 7.50%
D) 6.72%
21) AirH&H Inc. just paid a dividend of $1.33. Its stock has a dividend growth rate of 7.6% and
a required return of 12.21%. What is the current stock price if we anticipate dividends stopping
in 10 years?
A) $18.46
B) $21.03
C) $11.92
D) $10.64
22) Cavalier Custom Design Inc. just paid a dividend of $0.73. Its stock has a dividend growth
rate of 5.62% and a required return of 10.21%. What is the current stock price if we anticipate
dividends stopping in 20 years?
A) $4.62
B) $9.62
C) $10.62
D) $16.80
23) Rogue Motors Inc. has a 11% required rate of return. The firm does not expect to initiate
dividends for 10 years, at which time it will pay $2.00 per share in dividends. At that time, the
firm expects its dividends to grow at 6% forever. What is an estimate of the firms’ price in 10
years (P10) if its dividend at the end of year 10 is $2.00?
A) $42.40
B) $33.40
C) $31.20
D) $42.80
24) Nash Inc. has an 12% required rate of return. It does not expect to initiate dividends for 15
years, at which time it will pay $3.00 per share in dividends. At that time, Nash expects its
dividends to grow at 6% forever. What is an estimate of Nash’s price in 15 years (P15) if its
dividend at the end of year 15 is $3.00?
A) $33.33
B) $55.00
C) $57.50
D) $53.00
25) If we assume that a company will be in business forever and that it continues to pay
dividends during its existence, then we have an annuity dividend stream.
26) The dividend stream we would have legal claim to is for only that period of the company’s
life during which we own the stock or until the company goes out of business and stops paying
dividends.
27) If we believe that a company is following a constant dividend policy, we can then use the
current dividend to predict all future dividends because they are the same.
28) In applying the constant dividend model with infinite horizon to price a stock for purchase,
we assume the company will pay dividends forever and that we will hold onto our stock forever.
29) Maris Motors Co. pays a $2.15 dividend every quarter for its perpetual stock. If you expect
an annual return of 8.75% on your investment, compute the stock price that you would be willing
to pay, using quarterly data. Now compute the value using annual data. Explain your two
answers. What would you be willing to pay for 100 preferred shares?
30) Central Inc. has an 11.5% required rate of return. It does not expect to initiate dividends for
20 years, at which time it will pay $3.75 per share in dividends. At that time, Central expects its
dividends to grow at 6% forever. What is an estimate of Central’s price in 20 years (P20) if its
dividend at the end of year 20 is $3.75? What is its price in today’s dollars if you desire a rate of
return of 12%?
31) Pinecrest Inc. has a 13% required rate of return. It does not expect to initiate dividends for 10
years, at which time it will pay $5 per share in dividends. At that time Pinecrest expects its
dividends to grow at 5% forever. What is an estimate of Pinecrest’s price in 10 years (P10) if its
dividend at the end of year 10 is $5.00? What is its price in today’s dollars if you desire a rate of
return of 13%? Repeat the problem, but replace the 10 years with 30 years and compare the two
sets of prices. Describe the relationship between the number of years before you receive
dividends and today’s price.
24
Copyright © 2019 Pearson Education, Inc.
7.4 Dividend Model Shortcomings
1) Dividend models suggest that the value of a financial asset is determined by future cash flows.
A problem arises, however, in that future cash flows may be difficult to predict as to ________
of these cash flows.
A) both the timing and the amount
B) the timing but not the amount
C) the amount but not the timing
D) neither the timing nor the amount
2) Which of the statements below is TRUE?
A) A problem with using the dividend growth model is that it appears to underestimate the
expected return for all stocks.
B) A problem with using the dividend growth model is that it produces a negative expected
return whenever a firm cuts dividends.
C) A problem with using the dividend growth model is that it produces a positive expected return
whenever a firm cuts dividends.
D) A problem with using the dividend growth model is that it produces a negative expected
return whenever a firm increases its dividends.
3) Which of the statements below is FALSE?
A) The dividend model requires that a firm have a cash dividend history and that the dividend
history shows a constant dividend or a positive growth in dividends.
B) A problem with using the dividend growth model is that it appears to underestimate the
expected return for some stocks.
C) A problem with using the dividend growth model is that it produces a negative expected
return whenever a firm cuts its dividends.
D) A problem with using the dividend growth model is that it appears to underestimate the
expected return for all stocks.
4) Dividend models suggest that the value of a financial asset is determined by the ________ the
owner is entitled to while holding the asset.
A) present cash flows
B) past cash flows
C) future cash flows
D) past and present cash flows
5) The dividend model requires that a firm has a cash dividend history and that the dividend
history shows a ________.
A) constant dividend or a constant growth in price where constant growth can be either positive
or negative
B) positive dividend or a negative growth in dividends
C) constant dividend or a positive growth in dividends
D) constant price or a positive growth in dividends
6) Shortcomings of the dividend pricing models suggest that we need a pricing model that is
more inclusive than the dividend models and provides expected returns for companies based on
aspects besides their historical dividend patterns. Which of the below is NOT one of these
aspects?
A) The company’s risk
B) The premium for taking on risk
C) The reward for waiting
D) Stable dividends
7) Which of the statements below is FALSE?
A) Shortcomings of the dividend pricing models suggest that we need a pricing model that is
more inclusive and that can estimate expected returns for stocks without the need for a stable
dividend history.
B) A firm’s dividend in 2008 was less than its dividend in 2003. This means that the estimated
growth rate is negative, and this produces a negative expected return.
C) The dividend models (growth or constant dividend) appeal to a fundamental concept of
financial assets, that is, the value of the financial asset is determined by the future cash flow the
owner is entitled to while holding the asset.
D) Lack of a dividend pattern is not a problem for the dividend models to work.
8) The dividend models appeal to a fundamental concept of asset pricing—that the value of an
asset is determined by the future cash flow to which the owner is entitled while holding the asset,
and the required rate of return for the cash flow.
9) The dividend growth model has a limitation due to the necessity to have a non-growing
dividend pattern in order for it to work.
10) An application of the capital asset pricing model, called the security market line, is more
inclusive than the dividend growth model for pricing stocks and provides expected returns for
companies based on their risk, the premium for taking on risk, and the reward for waiting and not
on their historical pattern of dividends.
11) Mind-The-Gap Corp. is selling for $30 a share. In looking at the stream of dividends over the
past ten years, you find out that the first dividend was $1.00 and the last dividend was $2.00.
What is the firm’s growth rate of dividends? What is the firm’s expected return?
12) Famous Antiquities Inc. is selling for $48 per share. In looking at the stream of dividends
over the past seven years, you find out that the first dividend was $0.50 and the last dividend was
$3.85. What is the firm’s growth rate of dividends? What is the firm’s expected return?
1) Preferred stock ________.
A) reflects residual ownership of a company
B) represents a preferential claim on dividends
C) will be “paid” before the bondholders
D) always has a legal and specific claim to a fixed amount (listed as a liability)
2) Which of the statements below is FALSE?
A) It is common for companies to issue preferred stock with the right to convert to common
shares after a specific waiting period.
B) Preferred stock does not have a maturity date.
C) Preferred stock cannot be converted into common stock.
D) Preferred shareholders’ dividend claims take precedence over common shareholders’ dividend
claims.
3) The holder of preferred stock is entitled to a constant dividend ________.
A) every period
B) only when earnings are positive
C) only when the stock price increases
D) only when earnings are positive and only when the stock price increases
4) Which of the following statements is TRUE?
A) Preferred stock usually has a stated or par value and, like bonds, this par value is not repaid at
maturity because preferred stocks do not have a maturity date.
B) The par value for preferred stock, unlike bonds, is never paid back.
C) A preferred stock’s cash dividend due each year is based on the stated dividend rate times the
market value of the stock.
D) Some preferred stocks are cumulative with respect to dividends, meaning that if a company
skips a cash dividend, it must pay it at some point in the future.
5) Which of the following statements is FALSE?
A) Preferred stock usually has a stated or par value but unlike bonds, this par value is not repaid
at maturity because preferred stocks do not have a maturity date.
B) The only time the par value of preferred stock would be paid to the shareholder is if the
company ceases operations or retires the preferred stock.
C) Skipped preferred dividends become a liability of the company.
D) Preferred stock cannot be converted into common stock.
6) Peppercorn Inc. has outstanding nonconvertible preferred stock (cumulative) that pays a
quarterly dividend of $1.00. If your required rate of return is 8.0%, what should you be willing to
pay for 1000 shares of the firm?
A) $50,000.00
B) $52,621.58
C) $52,611.58
D) $52,601.58
7) Allison Corp. has just issued nonconvertible preferred stock (cumulative) with a par value of
$20 and an annual dividend rate of 4.25%. The preferred stock is currently selling for $18.75 per
share. What is the annual yield or return (r) on this preferred stock?
A) 4.11%
B) 4.87%
C) 4.26%
D) 4.53%
8) Buxton Corp. has outstanding borrowings. One of these borrowings is nonconvertible
preferred stock (cumulative) with a par value of $85 and an annual dividend rate of 6.20%. This
preferred stock is currently selling for $56.50 per share. What is the yield or return (r) on this
preferred stock?
A) 9.89%
B) 9.56%
C) 9.32%
D) 9.22%
9) The term “preferred” comes from the fact that preferred shareholders receive all past (if
cumulative) and present dividends before common shareholders can receive any cash
dividends—in other words, their dividend claims are preferred over common stock dividend
claims.
10) The term “preferred” comes from the fact that preferred shareholders receive, on average, a
higher rate of return than common shareholders even though they have less risk.
11) In valuing preferred stock, we can use either the constant dividend model or the growth
model with a positive growth rate.
12) Crane Industries Inc. has outstanding borrowings that include preferred stock. One of these
borrowings is (nonconvertible) preferred stock (cumulative) with a par value of $250 and an
annual dividend rate of 8.25%. This preferred stock is currently selling for $260 per share. What
is the yield or return on this nonconvertible preferred stock?
13) Sampson Supply Inc. has outstanding borrowings that include preferred stock. One of these
borrowings is (nonconvertible) preferred stock (cumulative) with a par value of $150 and an
annual dividend rate of 4.50%. This preferred stock is currently selling for $175 per share. What
is the yield or return on this nonconvertible preferred stock?
1) Strong-form efficient markets theory proclaims that ________.
A) one can chart historical stock prices to predict future stock prices such that you can identify
mispriced stocks and routinely outperform the market
B) one can exploit publicly available news or financial statement information to routinely
outperform the market
C) current prices reflect the price and volume history of the stock, all publicly available
information, and all private information
D) current prices reflect the price and volume history of the stock, all publicly available
information, but no private information
2) ________ has to do with the speed and accuracy of processing a buy or sell order at the best
available price.
A) Market efficiency
B) Mechanical efficiency
C) Informational efficiency
D) Operational efficiency
3) ________ refers to how quickly information is reflected in the available prices for trading.
A) Market efficiency
B) Mechanical efficiency
C) Informational efficiency
D) Operational efficiency
4) In ________, current prices reflect the price history and trading volume of the stock. It is of no
use to chart historical stock prices to predict future stock prices such that you can identify
mispriced stocks and routinely outperform the market.
A) weak-form efficient markets
B) strong-form efficient markets
C) semi-strong-form efficient markets
D) operational efficient markets
5) In ________, current prices already reflect the price history and volume of the stock as well as
all available public information.
A) weak-form efficient markets
B) strong-form efficient markets
C) semi-strong-form efficient markets
D) operationally efficient markets
6) The ________ are quite dynamic in terms of processing trades and incorporating information
in prices and thus are considered very efficient markets.
A) domestic bond markets
B) equity markets
C) fixed income markets
D) foreign bond markets
7) Most academic research supports markets as ________ efficient.
A) weak-form
B) semi-strong-form
C) strong-form
D) not at all
8) The NYSE uses a designated-order turnaround computer system (SuperDOT) that matches
buyers and sellers so that trades can be executed within seconds, with buyers and sellers getting
the best available price.
9) Most academic research supports markets as semi-strong efficient.
10) Informational efficiency has to do with the speed and accuracy of processing a buy or sell
order at the best available price.
11) In weak-form efficient markets, current prices already reflect the price history and volume of
the stock, as well as all available public information.
12) Describe the three forms of market efficiency.