25) In the Gordon model, the value of a common stock is the ________.
A) net value of all assets which are liquidated for their exact accounting value
B) actual amount each common stockholder would expect to receive if the firm’s assets are sold
C) present value of a non-growing dividend stream
D) present value of a constant growing dividend stream
26) Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of
dividends of 10 percent, and a required return of 20 percent. The value of a share of Emmy Lou,
Inc.’s common stock is ________.
A) $28.00
B) $56.00
C) $22.40
D) $18.67
27) A firm has experienced a constant annual rate of dividend growth of 9 percent on its
common stock and expects the dividend per share in the coming year to be $2.70. The firm can
earn 12 percent on similar risk involvements. The value of the firm’s common stock is ________.
A) $22.50/share
B) $9/share
C) $90/share
D) $30/share
28) You are planning to purchase the stock of Ted’s Sheds Inc. and you expect it to pay a
dividend of $3 in 1 year, $4.25 in 2 years, and $6.00 in 3 years. You expect to sell the stock for
$100 in 3 years. If your required return for purchasing the stock is 12 percent, how much would
you pay for the stock today?
A) $75.45
B) $77.24
C) $81.52
D) $85.66
29) Smith Corporation’s common stock is expected to pay a dividend of $3.00 forever and
currently sells for $21.42. What is the required rate of return?
A) 10%
B) 12%
C) 13%
D) 14%
30) Julian is considering purchasing the stock of Pepsi Cola because he really loves the taste of
Pepsi. What should Julian be willing to pay for Pepsi today if it is expected to pay a $2 dividend
in one year and he expects dividends to grow at 5 percent indefinitely? Julian requires a 12
percent return to make this investment.
A) $28.57
B) $29.33
C) $31.43
D) $43.14
31) Harry Corporation’s common stock currently sells for $180 per share. Harry just paid a
dividend of $10.18 and dividends are expected to grow at a constant rate of 6 percent forever. If
the required rate of return is 12 percent, what will Harry Corporation’s stock sell for one year
from now?
A) $190.64
B) $187.04
C) $195.40
D) $179.84
32) Tangshan China Company’s stock is currently selling for $80.00 per share. The expected
dividend one year from now is $4.00 and the required return is 13 percent. What is Tangshan’s
dividend growth rate assuming that dividends are expected to grow at a constant rate forever?
A) 8%
B) 9%
C) 10%
D) 11%
33) Tangshan China’s stock is currently selling for $160.00 per share and the firm’s dividends are
expected to grow at 5 percent indefinitely. Assuming Tangshan China’s most recent dividend
was $5.50, what is the required rate of return on Tangshan’s stock?
A) 7.3%
B) 8.4%
C) 9.5%
D) 10.6%
34) Daniel Custom Cycles’ common stock currently pays no dividends. The company plans to
begin paying dividends beginning 3 years from today. The first dividend will be $3.00 and
dividends will grow at 5 percent per year thereafter. Given a required return of 15 percent, what
would you pay for the stock today?
A) $25.33
B) $18.73
C) $29.86
D) $22.68
35) Jia’s Fashions recently paid a $2 annual dividend. The company is projecting that its
dividends will grow by 20 percent next year, 12 percent annually for the two years after that, and
then at 6 percent annually thereafter. Based on this information, how much should Jia’s Fashions
common stock sell for today if her required return is 10.5%?
A) $54.90
B) $60.80
C) $59.16
D) $69.30
36) The board of directors of Ride World, Inc. has declared $5.00 common stock dividend and
accepted a plan to freeze the dividend at $5 per year indefinitely. What is the value of the Ride
World’s common stock if the required rate of interest is 15 percent?
37) Jia’s Kitchen Stuff has recently sold 1,000 shares of preferred stock. What is the value of the
stock assuming 10 percent required rate of return and a preferred dividend of $6.75?
38) Aunt Tilly’s Fur Company has been experiencing several years of financial difficulty and,
thus, has considered maintaining its dividend payment at $2.50 indefinitely. What is the value of
its common stock if the required rate of return is 8.5 percent?
39) 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?
40) Uncle Tim’s Inventions has an expected dividend next year of $3.60 and a required return of
12 percent. Assuming the dividends will be paid indefinitely, calculate the value of a share of
common stock assuming a zero growth rate of dividends.
41) 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 as the risk-free rate increases? Explain.
42) 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 rate of interest
is 8 percent?
43) 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?
44) Tina’s Medical Equipment Company paid $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?
45) Angel recently purchased a block of 100 shares of Hayley’s Optical common stock for
$6,000. The stock is expected to provide an annual cash flow of dividends of $400 indefinitely.
Assuming a discount rate of 8 percent, how does the price Angel paid compare to the value of
the stock?
46) 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?
Table 7.1
47) 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.
48) Calculate the estimated dividend for 2015. (See Table 7.1)
49) The required return is assumed to be 17 percent. Using the Gordon model, calculate the per
share value of the stock for 2014. (See Table 7.1)
50) China America Manufacturing has a beta of 1.50, the risk-free rate of interest is currently 12
percent, and the required return on the market portfolio is 18 percent. The company plans to pay
a dividend of $2.45 per share in the coming year and anticipates that its future dividends will
increase at an annual rate consistent with that experienced over the 2001-2003 period.
Estimate the value of China America Manufacturing’s stock.
51) Julie’s X-Ray Company paid $2.00 per share in common stock dividends last year. The
company’s policy is to allow its dividend to grow at 5 percent for 4 years and then the rate of
growth changes to 3 percent per year from year five and on. 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 10
percent required rate of return.
7.5 Discuss the free cash flow valuation model and the book value, liquidation value, and
price/earnings (P/E) multiple approaches.
1) 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.
2) 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.
3) 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.
4) In valuation of common stock, the price/earnings multiple approach is considered superior to
the use of book or liquidation values since it considers expected earnings.