CHAPTER 09—STOCKS AND THEIR VALUATION
1. A proxy is a document giving one party the authority to act for another party, including the power to vote shares of
common stock. Proxies can be important tools relating to control of firms.
a.
True
b.
False
True
EASY
9-1 Legal Rights and Privileges of Common Stockholders
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Proxy
2. The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the
firm. This right helps protect current stockholders against both dilution of control and dilution of value.
a.
True
b.
False
True
EASY
9-1 Legal Rights and Privileges of Common Stockholders
FOFM.BRIG.16.09.01 – Legal Rights and Privileges of Common Stockholders
United States – OH – DISC.FOFM.BRIG.16.01 – Stocks and bonds
Preemptive right
3. If a firm’s stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting
to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in
management through a proxy fight.
a.
True
b.
False
False
EASY
9-1 Legal Rights and Privileges of Common Stockholders
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Preemptive right
Bloom’s: Comprehension
4. Classified stock differentiates various classes of common stock, and using it is one way companies can meet special
needs such as when owners of a start-up firm need additional equity capital but don’t want to relinquish voting control.
CHAPTER 09—STOCKS AND THEIR VALUATION
a.
True
b.
False
True
EASY
5. Founders’ shares are a type of classified stock where the shares are owned by the firm’s founders, and they generally
have more votes per share than the other classes of common stock.
a.
True
b.
False
True
EASY
6. The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased
and sold.
a.
True
b.
False
False
EASY
7. The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock
has a residual claim against the company versus a contractual obligation for a bond.
a.
True
b.
False
CHAPTER 09—STOCKS AND THEIR VALUATION
True
EASY
8. According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent
on the length of time he or she plans to hold the stock.
a.
True
b.
False
False
EASY
9. When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock
will trade.
a.
True
b.
False
True
EASY
10. The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model
used to find the price of perpetual preferred stock or other perpetuities.
a.
True
b.
False
True
CHAPTER 09—STOCKS AND THEIR VALUATION
11. According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value
of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash
flows during the subsequent constant growth period.
a.
True
b.
False
True
EASY
12. The corporate valuation model can be used only when a company doesn’t pay dividends.
a.
True
b.
False
False
EASY
13. The corporate valuation model cannot be used unless a company pays dividends.
a.
True
b.
False
False
EASY
CHAPTER 09—STOCKS AND THEIR VALUATION
14. Projected free cash flows should be discounted at the firm’s weighted average cost of capital to find the firm’s total
corporate value.
a.
True
b.
False
True
EASY
15. Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends
that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
a.
True
b.
False
False
EASY
16. From an investor’s perspective, a firm’s preferred stock is generally considered to be less risky than its common stock
but more risky than its bonds. However, from a corporate issuer’s standpoint, these risk relationships are reversed: bonds
are the most risky for the firm, preferred is next, and common is least risky.
a.
True
b.
False
True
EASY
CHAPTER 09—STOCKS AND THEIR VALUATION
17. If a stock’s expected return as seen by the marginal investor exceeds this investor’s required return, then the investor
will buy the stock until its price has risen enough to bring the expected return down to equal the required return.
a.
True
b.
False
True
EASY
9A Stock Market Equilibrium
18. If a stock’s market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the
stock until its price has fallen down to the level of the investor’s estimate of the intrinsic value.
a.
True
b.
False
True
EASY
9A Stock Market Equilibrium
19. For a stock to be in equilibrium, two conditions are necessary: (1) The stock’s market price must equal its intrinsic
value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this
investor’s required return.
a.
True
b.
False
True
EASY
9A Stock Market Equilibrium
CHAPTER 09—STOCKS AND THEIR VALUATION
20. Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock’s market price equal
its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal
investor equal this investor’s required return? If either of these conditions, but not necessarily both, holds, then the stock is
said to be in equilibrium.
a.
True
b.
False
False
EASY
9A Stock Market Equilibrium
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Stock market equilibrium
21. Which of the following statements is CORRECT?
a.
The constant growth model is often appropriate for evaluating start-up companies that do not have a stable
history of growth but are expected to reach stable growth within the next few years.
b.
If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%,
this implies that the stock’s dividend yield is also 5%.
c.
The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to
decline at a constant rate, i.e., to grow at a negative rate.
d.
The price of a stock is the present value of all expected future dividends, discounted at the dividend growth
rate.
e.
The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain
constant over time.
c
EASY
9-5 Constant Growth Stocks
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Constant growth model
Multiple Choice: Conceptual
22. An increase in a firm’s expected growth rate would cause its required rate of return to
a.
increase.
b.
decrease.
c.
fluctuate less than before.
CHAPTER 09—STOCKS AND THEIR VALUATION
d.
fluctuate more than before.
e.
possibly increase, possibly decrease, or possibly remain constant.
9-5 Constant Growth Stocks
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Required return
Bloom’s: Comprehension
Multiple Choice: Conceptual
23. If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor
thinks
a.
the stock is experiencing supernormal growth.
b.
the stock should be sold.
c.
the stock is a good buy.
d.
management is probably not trying to maximize the price per share.
e.
dividends are not likely to be declared.
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Required return
Bloom’s: Comprehension
Multiple Choice: Conceptual
24. If markets are in equilibrium, which of the following conditions will exist?
a.
Each stock’s expected return should equal its realized return as seen by the marginal investor.
b.
Each stock’s expected return should equal its required return as seen by the marginal investor.
c.
All stocks should have the same expected return as seen by the marginal investor.
d.
The expected and required returns on stocks and bonds should be equal.
e.
All stocks should have the same realized return during the coming year.
9A Stock Market Equilibrium
CHAPTER 09—STOCKS AND THEIR VALUATION
25. The preemptive right is important to shareholders because it
a.
allows managers to buy additional shares below the current market price.
b.
will result in higher dividends per share.
c.
is included in every corporate charter.
d.
protects the current shareholders against a dilution of their ownership interests.
e.
protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
9-1 Legal Rights and Privileges of Common Stockholders
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Preemptive right
Bloom’s: Comprehension
Multiple Choice: Conceptual
26. Companies can issue different classes of common stock. Which of the following statements concerning stock classes
is CORRECT?
a.
All common stocks fall into one of three classes: A, B, and C.
b.
All common stocks, regardless of class, must have the same voting rights.
c.
All firms have several classes of common stock.
d.
All common stock, regardless of class, must pay the same dividend.
e.
Some class or classes of common stock are entitled to more votes per share than other classes.
9-2 Types of common Stock
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Classified stock
Multiple Choice: Conceptual
27. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
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Market equilibrium
Bloom’s: Comprehension
Multiple Choice: Conceptual
CHAPTER 09—STOCKS AND THEIR VALUATION
A
B
Required return
10%
12%
Market price
$25
$40
Expected growth
7%
9%
a.
These two stocks should have the same price.
b.
These two stocks must have the same dividend yield.
c.
These two stocks should have the same expected return.
d.
These two stocks must have the same expected capital gains yield.
e.
These two stocks must have the same expected year-end dividend.
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Required return
Bloom’s: Analysis
Multiple Choice: Conceptual
28. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
A
B
Price
$25
$40
Expected growth
7%
9%
Expected return
10%
12%
a.
The two stocks should have the same expected dividend.
b.
The two stocks could not be in equilibrium with the numbers given in the question.
c.
A’s expected dividend is $0.50.
d.
B’s expected dividend is $0.75.
e.
A’s expected dividend is $0.75 and B’s expected dividend is $1.20.
e
CHAPTER 09—STOCKS AND THEIR VALUATION
29. Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which
of the following statements is CORRECT?
a.
If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock
B’s.
b.
Stock B must have a higher dividend yield than Stock A.
c.
Stock A must have a higher dividend yield than Stock B.
d.
If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock
B’s.
e.
Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
9-5 Constant Growth Stocks
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Dividend yield and g
Bloom’s: Analysis
Multiple Choice: Conceptual
30. Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which
of the following statements is CORRECT?
a.
The two stocks must have the same dividend per share.
b.
If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
c.
If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
d.
The two stocks must have the same dividend growth rate.
e.
The two stocks must have the same dividend yield.
9-5 Constant Growth Stocks
FOFM.BRIG.16.09.05 – Constant Growth Stocks
9-5 Constant Growth Stocks
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Required return
Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 09—STOCKS AND THEIR VALUATION
31. Which of the following statements is CORRECT, assuming stocks are in equilibrium?
a.
The dividend yield on a constant growth stock must equal its expected total return minus its expected capital
gains yield.
b.
Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate of
5%, its expected dividend yield is 5% as well.
c.
A stock’s dividend yield can never exceed its expected growth rate.
d.
A required condition for one to use the constant growth model is that the stock’s expected growth rate exceeds
its required rate of return.
e.
Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return.
9-5 Constant Growth Stocks
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Dividend yield and g
Multiple Choice: Conceptual
32. A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate
of 5% a year forever (g = −5%). If the company is in equilibrium and its expected and required rate of return is 15%,
which of the following statements is CORRECT?
a.
The company’s current stock price is $20.
b.
The company’s dividend yield 5 years from now is expected to be 10%.
c.
The constant growth model cannot be used because the growth rate is negative.
d.
The company’s expected capital gains yield is 5%.
e.
The company’s expected stock price at the beginning of next year is $9.50.
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Declining constant growth
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Dividend yield and g
Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 09—STOCKS AND THEIR VALUATION
33. Which of the following statements is CORRECT?
a.
The constant growth model takes into consideration the capital gains investors expect to earn on a stock.
b.
Two firms with the same expected dividend and growth rate must also have the same stock price.
c.
It is appropriate to use the constant growth model to estimate a stock’s value even if its growth rate is never
expected to become constant.
d.
If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of
5%, this implies that the stock’s dividend yield is also 5%.
e.
The price of a stock is the present value of all expected future dividends, discounted at the dividend growth
rate.
9-5 Constant Growth Stocks
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Constant growth model
Bloom’s: Comprehension
Multiple Choice: Conceptual
34. If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is
CORRECT? The stock is in equilibrium.
a.
The expected return on the stock is 5% a year.
b.
The stock’s dividend yield is 5%.
c.
The price of the stock is expected to decline in the future.
d.
The stock’s required return must be equal to or less than 5%.
e.
The stock’s price one year from now is expected to be 5% above the current price.
Statement e is true, because the stock price is expected to grow at the dividend growth rate.
9-5 Constant Growth Stocks
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Constant growth model
Bloom’s: Comprehension
Multiple Choice: Conceptual
35. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 09—STOCKS AND THEIR VALUATION
which of the following statements is CORRECT?
A
B
Price
$25
$25
Expected growth (constant)
10%
5%
Required return
15%
15%
a.
Stock A’s expected dividend at t = 1 is only half that of Stock B.
b.
Stock A has a higher dividend yield than Stock B.
c.
Currently the two stocks have the same price, but over time Stock B’s price will pass that of A.
d.
Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high
as Stock B’s.
e.
The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
a
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Constant growth model
Bloom’s: Analysis
Multiple Choice: Conceptual
36. Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
X
Y
Price
$30
$30
Expected growth (constant)
6%
4%
Required return
12%
10%
a.
Stock X has a higher dividend yield than Stock Y.
b.
Stock Y has a higher dividend yield than Stock X.
c.
One year from now, Stock X’s price is expected to be higher than Stock Y’s price.
d.
Stock X has the higher expected year-end dividend.
e.
Stock Y has a higher capital gains yield.
c
CHAPTER 09—STOCKS AND THEIR VALUATION
37. Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the
following statements is CORRECT?
Expected dividend, D1
$3.00
Current Price, P0
$50
Expected constant growth rate
6.0%
a.
The stock’s required return is 10%.
b.
The stock’s expected dividend yield and growth rate are equal.
c.
The stock’s expected dividend yield is 5%.
d.
The stock’s expected capital gains yield is 5%.
e.
The stock’s expected price 10 years from now is $100.00.
MODERATE
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Constant growth model
Bloom’s: Analysis
Multiple Choice: Conceptual
38. Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
X
Y
Price
$25
$25
Expected dividend yield
5%
3%
Required return
12%
10%
a.
Stock Y pays a higher dividend per share than Stock X.
b.
Stock X pays a higher dividend per share than Stock Y.
MODERATE
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Constant growth model
Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 09—STOCKS AND THEIR VALUATION
c.
One year from now, Stock X should have the higher price.
d.
Stock Y has a lower expected growth rate than Stock X.
e.
Stock Y has the higher expected capital gains yield.
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Constant growth model
Bloom’s: Analysis
Multiple Choice: Conceptual
39. The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate
of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?
a.
The stock’s dividend yield is 7%.
b.
The stock’s dividend yield is 8%.
c.
The current dividend per share is $4.00.
d.
The stock price is expected to be $54 a share one year from now.
e.
The stock price is expected to be $57 a share one year from now.
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Constant growth model
Bloom’s: Analysis
Multiple Choice: Conceptual
40. Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming
the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A
B
Beta
1.10
0.90
Constant growth rate
7.00%
7.00%
a.
Stock A must have a higher stock price than Stock B.
b.
Stock A must have a higher dividend yield than Stock B.
CHAPTER 09—STOCKS AND THEIR VALUATION
c.
Stock B’s dividend yield equals its expected dividend growth rate.
d.
Stock B must have the higher required return.
e.
Stock B could have the higher expected return.
b
1
MODERATE
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Constant growth model and CAPM
Bloom’s: Analysis
Multiple Choice: Conceptual
41. Which of the following statements is NOT CORRECT?
a.
The corporate valuation model can be used both for companies that pay dividends and those that do not pay
dividends.
b.
The corporate valuation model discounts free cash flows by the required return on equity.
c.
The corporate valuation model can be used to find the value of a division.
d.
An important step in applying the corporate valuation model is forecasting the firm’s pro forma financial
statements.
e.
Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or
continuing, value.
b
1
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Corporate valuation model
Multiple Choice: Conceptual
42. Which of the following statements is CORRECT?
a.
To implement the corporate valuation model, we discount projected free cash flows at the weighted average
CHAPTER 09—STOCKS AND THEIR VALUATION
cost of capital.
b.
To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the
weighted average cost of capital.
c.
To implement the corporate valuation model, we discount projected net income at the weighted average cost
of capital.
d.
To implement the corporate valuation model, we discount projected free cash flows at the cost of equity
capital.
e.
The corporate valuation model requires the assumption of a constant growth rate in all years.
a
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Corporate valuation model
Multiple Choice: Conceptual
43. Which of the following statements is CORRECT?
a.
Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to
the proceeds in a liquidation.
b.
The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.
c.
Corporations cannot buy the preferred stocks of other corporations.
d.
Preferred dividends are not generally cumulative.
e.
A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing
corporation.
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Preferred stock concepts
Multiple Choice: Conceptual
44. Which of the following statements is CORRECT?
a.
A major disadvantage of financing with preferred stock is that preferred stockholders typically have
supernormal voting rights.
b.
Preferred stock is normally expected to provide steadier, more reliable income to investors than the same
firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax
expected return on the common stock.
c.
The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to
CHAPTER 09—STOCKS AND THEIR VALUATION
purchase (on a pro rata basis) new issues of preferred stock.
d.
One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received
represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax
free.
e.
One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax
deductible to the issuer.
MODERATE
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United States – OH – DISC.FOFM.BRIG.16.01 – Stocks and bonds
Preferred stock concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
45. For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current
level, then
a.
the expected future return must be less than the most recent past realized return.
b.
the past realized return must be equal to the expected return during the same period.
c.
the required return must equal the realized return in all periods.
d.
the expected return must be equal to both the required future return and the past realized return.
e.
the expected future return must be equal to the required return.
e
MODERATE
9A Stock Market Equilibrium
FOFM.BRIG.16.09.09A – Stock Market Equilibrium
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.01 – Stocks and bonds
Market equilibrium
Bloom’s: Comprehension
Multiple Choice: Conceptual
46. Which of the following statements is CORRECT?
a.
If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends,
but under all state charters the two classes must have the same voting rights.
b.
The preemptive right gives stockholders the right to approve or disapprove of a merger between their company
and some other company.
c.
The preemptive right is a provision in the corporate charter that gives common stockholders the right to
purchase (on a pro rata basis) new issues of the firm’s common stock.
d.
The stock valuation model, P0 = D1/(rs − g), cannot be used for firms that have negative growth rates.
e.
The stock valuation model, P0 = D1/(rs − g), can be used only for firms whose growth rates exceed their
required return.
CHAPTER 09—STOCKS AND THEIR VALUATION
c
MODERATE
Comprehensive
FOFM.BRIG.16.09.00 – Comprehensive
United States – BUSPROG.FOFM.BRIG.16.06 – Reflective thinking
United States – OH – DISC.FOFM.BRIG.16.01 – Stocks and bonds
Common stock concepts
Multiple Choice: Conceptual
47. The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is
CORRECT?
a.
If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the
higher expected growth rate.
b.
If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains
yield than Stock X.
c.
If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then
Stock Y must sell for a higher price.
d.
The stocks must sell for the same price.
e.
Stock Y must have a higher dividend yield than Stock X.
a
MODERATE
Comprehensive
FOFM.BRIG.16.09.00 – Comprehensive
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.01 – Stocks and bonds
Common stock concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
48. A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the
expected constant growth rate is g = 6.4%. What is the stock’s current price?
a.
$17.39
b.
$17.84
c.
$18.29
d.
$18.75
e.
$19.22