Chapter 5—Valuing Stocks
MULTIPLE CHOICE
1. The first public sale of company stock to outside investors is called a/an
a.
seasoned equity offering.
b.
shareholders’ meeting.
c.
initial public offering.
d.
proxy fight.
2. Which statement about common shareholders is incorrect?
a.
Shareholders only have a residual claim.
b.
Shareholders have precedence over all other claimholders in the case of bankruptcy.
c.
Shareholders have a voting right.
d.
Shareholders are the ultimate owners of a corporation.
3. What is the market capitalization of a company?
a.
The market value of all outstanding debt.
b.
The book value of the company’s debt.
c.
The market value of all outstanding shares.
d.
The book value of the company’s total equity.
4. Which of the following is not a difficulty associated with valuing common stock?
a.
Common stock does not have a specific expiration date.
b.
The required rate of return is difficult to estimate.
c.
Common stock does not promise a fixed cash flow stream.
d.
All of the above are considered difficulties associated with valuing common stock.
5. Which of the following stock exchanges has the most strict listing requirements?
a.
American Stock Exchange
b.
NASDAQ
c.
New York Stock Exchange
d.
Pacific Stock Exchange
6. Bavarian Sausage, Inc. has preferred stock outstanding. This stock pays a semiannual dividend of
$1.25. If the next dividend is paid six months from now and the annual required return is 10%, what
should be the value of the preferred stock?
a.
$6.25
b.
$25
c.
$12.50
d.
$50.00
7. Bavarian Sausage just paid a $1.57 dividend and investors expect that dividend to grow by 5% each
year forever. If the required return on the stock investment is 14%, what should be the price of the
stock today.
a.
$11.21
b.
$18.32
c.
$17.44
d.
$25.37
8. Bavarian Sausage is expected to pay a $1.57 dividend next year and investors expect that dividend to
grow by 5% each year forever. If the required return on the stock investment is 14%, what should be
the price of the stock today.
a.
$18.32
b.
$17.44
c.
$11.21
d.
$25.37
9. Bavarian Sausage just paid a $1.57 dividend and investors expect that dividend to grow by 5% each
year forever. If the required return on the stock investment is 14%, what should be the price of the
stock in 5 years?
a.
$18.32
b.
$23.33
c.
$17.44
d.
$22.26
10. Bavarian Sausage is expected to pay a $1.57 dividend next year and investors expect that dividend to
grow by 5% each year forever. If the required return on the stock investment is 14%, what should be
the price of the stock in 5 years?
a.
$18.32
b.
$22.28
c.
$21.22
d.
$17.44
11. Smith Construction, Inc. just paid a $2.78 dividend. The dividend is expected to grow by 4% each year
for the next three years. After that the company will never pay another dividend ever again. If your
required return on the stock investment is 10%, what should the stock sell for today?
a.
$7.46
b.
$28.91
c.
$46.33
d.
$15.63
12. Smith Construction, Inc. is expected to pay a $2.78 dividend next year. The dividend is expected to
grow by 4% each year for the next three years. After that the company will never pay another dividend
ever again. If your required return on the stock investment is 10%, what should the stock sell for
today?
a.
$7.46
b.
$28.91
c.
$35.06
d.
$9.31
13. Miller Juice, Inc. is not paying a dividend right now, but is expected to pay a $4.56 dividend two years
from now. Investors expect that dividend to grow by 4% every year forever. If the required return on
the stock investment is 14%, what should be the price of Miller Juice stock today?
a.
$53.69
b.
$36.49
c.
$47.42
d.
$43.84
14. Miller Juice, Inc. just paid a $3 dividend. The company is expected to pay a $3.50 dividend next year
and a $4 dividend in two years. After that, dividends are expected to grow at 5% forever. If investors
require a return of 12% on the investment, what should Miller Juice stock sell for today?
a.
$54.15
b.
$49.63
c.
$57.15
d.
$60.00
15. Miller Juice, Inc. is expected to pay a $3.00 dividend next year and a $4 dividend in two years. After
that, dividends are expected to grow at 5% forever. If investors require a return of 12% on the
investment, what should Miller Juice stock sell for today?
a.
$60.00
b.
$54.15
c.
$49.39
d.
$53.70
16. Miller Juice traditionally pays out 35% of its earnings as dividends. Last year Miller’s earnings
available for common stockholders were $256 million and the book value of its equity was $678
million. What is Miller’s growth rate?
a.
24.54%
b.
35.00%
c.
37.76%
d.
13.22%
17. Miller Juice traditionally retains 65% of its earnings for future investments. Last year Miller’s return
on equity was 15%. What is Miller’s growth rate?
a.
15.00%
b.
9.75%
c.
5.25%
d.
18.38%
18. Bavarian Sausage free cash flow for the current year is $6,750,000 and investors believe that the
company’s free cash flow will grow by 5% annually forever. If Bavarian sausage’s weighted average
cost of capital is 15%, what is their enterprise value?
a.
$67,500,000
b.
$85,350,000
c.
$56,780,000
d.
$70,875,000
19. Bavarian Sausage’s enterprise value is $75,000,000, the market value of its debt is $23,000,000 and
the company does not have any preferred stock outstanding. If the company has 3,500,000 shares
outstanding, what should be Bavarian Sausage’s stock price?
a.
$21.43
b.
$14.86
c.
$28.00
d.
$6.57
20. Bavarian Sausage’s enterprise value is $75,000,000, the market value of its debt is $23,000,000 and
the market value of its preferred stock is $5,000,000. If the company has 3,500,000 shares outstanding,
what should be Bavarian Sausage’s stock price?
a.
$14.86
b.
$21.43
c.
$13.43
d.
$6.57
21. Bavarian Sausage is expected to pay a $1.57 dividend next year. If the required return on the stock
investment is 14%, and the stock currently sells for $34.37, what is the implied dividend growth rate
for this company?
a.
6.37%
b.
9.43%
c.
12.68%
d.
15.76%
22. Bavarian Sausage just paid a $1.57 dividend. If the required return on the stock investment is 14%, and
the stock currently sells for $34.37, what is the implied dividend growth rate for this company?
a.
9.02%
b.
6.39%
c.
12.68%
d.
9.43%
NARRBEGIN: Miller Juice
Miller Juice
Miller Juice is a young company that currently does not pay a dividend. The company retains all their
earnings to finance their growth. However, ten years from now the company is expected to start paying
a $1.50 dividend. According to research reports the dividend should then grow by 5% annually
forever.
NARREND
23. If the required return on the stock investment is 13%, what should be Miller’s stock price today?
a.
$19.69
b.
$6.24
c.
$15.62
d.
$10.37
24. If the required return on the stock investment is 13%, what should be Miller’s stock price five years
from today?
a.
$11.50
b.
$6.24
c.
$19.69
d.
$16.28
25. If the required return on the stock investment is 13%, what should be Miller’s stock price immediately
after the first dividend was paid?
a.
$6.24
b.
$19.69
c.
$16.28
d.
$21.19
26. Which of the following investors can force a firm into bankruptcy court if the firm does not pay the
expected cash flow to the investor?
a.
common equity investor
b.
preferred equity investor
c.
debt investor
d.
none of the above
27. Which of the following securities poses the greatest financial risk for the investor?
a.
common equity
b.
preferred equity
c.
debt
d.
convertible debt
28. MeFirst Corporation has a cumulative preferred share issue that is suppose to pay a quarterly dividend
of $2. MeFirst failed to pay 3 consecutive dividends to investors and then managed to pay a common
share dividend the very next quarter. How much cash must MeFirst have paid to each preferred share
holder at that time?
a.
$2 per share
b.
$6 per share
c.
$8 per share
d.
$10 per share
29. Retained earnings represents
a.
a pool of cash that the firm can use should a need for cash arise.
b.
the increased market value, due to managements efforts, of all of the firms equity
securities issued.
c.
earnings that a firm reinvested during the firm’s history.
d.
the cumulative amount of cash that the firm has paid out in dividends.
30. Usually, only the riskiest type of firms will offer securities to the general public through
a.
a firm-commitment offering.
b.
a competitive offering.
c.
a negotiated offering.
d.
a best-efforts arrangement.
31. Which of the following is not the responsibility of the lead underwriter for an equity issuance?
a.
price stabilization of the issue
b.
exercises discretion over the distribution of shares for sale among the syndicate and the
selling group
c.
must buy the shares in the green shoe option
d.
many times serves as the market maker for trading in the issuers securities
32. Which of the following is not an important consideration when an underwriter is trying to establish the
price for an initial public offering?
a.
the underwriter’s reputation
b.
the value of the firm
c.
the demand for the securities of the issuer
d.
providing the absolute maximum price possible for the issuer of the shares
33. The vast majority of initial public offerings have underwriting spreads that cost the firm what
percentage of the net capital raised?
a.
0.5%
b.
7.0%
c.
7.5%
d.
8.0%
34. The Over-the-Counter Market for trading equity securities is located
a.
in New York City.
b.
in Chicago.
c.
in Boston.
d.
none of the above
35. The largest stock exchange in the world is
a.
the London Stock Exchange.
b.
the New York Stock Exchange.
c.
the NASDAQ.
d.
the Paris Bourse.
36. If viewing a stock quote from the Wall Street Journal, the columns labeled “HI” and “LO” refer to
a.
the highest and lowest prices at which the stock was sold in the last fifty-two weeks.
b.
the highest and lowest prices at which the stock was sold in the last six months.
c.
the highest and lowest prices at which the stock was sold in the last month.
d.
the highest and lowest prices at which the stock was purchased in the last month.
37. When valuing a preferred stock, the type of security that we treat the preferred stock like, for valuation
purposes, is
a.
a bond.
b.
a perpetuity.
c.
a common stock.
d.
none of the above.
38. AlwaysAround Co. has just issued a preferred stock that pays an annual $4 dividend. The first
dividend will be received one year from today. If the required rate of return on this stock is 5%, then
what is the price of the stock?
a.
$3.81
b.
$4.20
c.
$80.00
d.
none of the above
39. The Perp, Inc. has a preferred stock that will pay its next annual $5 dividend one year from now. The
current price of the stock is $110. What is the required rate of return on the stock?
a.
4.55%
b.
4.00%
c.
5.50%
d.
22.00%
40. You are approached about purchasing a share of common stock in a company that will definitely go
out of business exactly 2 years from today. The company is anticipated to pay a $10 dividend one year
from now and a $15 dividend two years from now (immediately before it goes out of business). What
price are you willing to pay for the stock if the required rate of return on the stock is 5%?
a.
$22.68
b.
$23.13
c.
$23.81
d.
$25.00
41. Static Utility Company anticipates its revenues, and consequently its common stock dividends, will
remain flat forever. It currently pays an annual dividend of $20 per year. If it pays the next dividend
exactly one year from today, then what is the price of Static’s common shares if the required rate of
return is 12%?
a.
$24.00
b.
$40.00
c.
$166.67
d.
$200.00
42. ConsGrough, Inc. has increased its annual common dividend by 3% in each of the years that the
company has existed. If you believe that the company can continue to do so indefinitely, then what
price would you be will to pay for ConsGrough if the required rate of return is 6% and the dividend
that it paid yesterday was $5?
a.
$85.83
b.
$166.67
c.
$171.67
d.
$200.00
43. ConsGrough, Inc. has increased its annual common dividend by 3% in each of the years that the
company has existed. If you believe that the company can continue to do so indefinitely, then what is
the required rate of return if the price of ConsGrough is $171.67 and the dividend that it paid yesterday
was $5?
a.
.029
b.
.03
c.
.06
d.
none of the above
44. Predictable Corp has increased its annual dividend each year of its life by 2% (and will continue to do
so indefinitely). If Predictable paid its annual dividend yesterday of $8 and the cost of capital is
currently 4%, then by what amount will the stock price decrease by if the cost of capital increases to
5%?
a.
$408.00
b.
$272.00
c.
$136.00
d.
none of the above
45. You are asked by the Chief Financial Officer of your firm to predict what the firm’s stock price will be
exactly 4 years from today. If your firm is expected to grow at 3% indefinitely and the cost of capital is
10% while the expected annual dividend one year from today is $10, then what should be the price of
your firm’s stock 4 years from today?
a.
$142.86
b.
$160.79
c.
$112.55
d.
none of the above
46. Last year Sample Corp. had earnings of $3 a share based upon a common share book value of $25 per
share. If Sample paid a dividend of $1.50 last year then estimate Sample’s growth rate.
a.
6%
b.
12%
c.
50%
d.
none of the above
47. Balance Corp. has a weighted average cost of capital equal to 5.5%. If the firm is financed with 25%
equity and 75% debt and if the after-tax of that debt is 4%, then what is the cost of equity for the firm?
a.
.025
b.
.06
c.
.1
d.
none of the above
48. Borrower Corp. has the ability to produce $4,000,000 of free cash flow next year and expects that to
grow by 2% per year thereafter. If Borrower’s weighted average cost of capital is 13%, then what is
the value of Borrower?
a.
$40,000,000.00
b.
$30,769,230.77
c.
$36,363,636.36
d.
none of the above
49. Equal, Inc. is financed with equal portions of debt and equity. The after-tax cost of debt is 6% and the
cost of equity is 8%. If Equal expects next year’s free cash flow to be $25,000,000 with growth of 3%
thereafter, what is the value of Equal, Inc. to the nearest dollar? Equal’s marginal tax rate is 35%.
a.
$357,142,857
b.
$625,000,000
c.
$833,333,333
d.
none of the above
50. Undetermined Corporation currently has a 10% weighted average cost of capital. It is concerned that
its after-tax cost of debt will increase in the near future by 2%. If Undetermined finances its projects
with 30% debt, then what will the new weighted average cost of capital for Undetermined be?
a.
12.0%
b.
13. %
c.
10.6%
d.
none of the above
51. Which is TRUE concerning preferred stock?
a.
Preferred stock is considered debt on the company balance sheet.
b.
Preferred stock holders have voting rights for the company board of directors.
c.
Preferred stock payments are variable like common stock.
d.
Preferred stock is viewed as less risky than a firm’s common stock.
NARRBEGIN: Kramerica, Inc.
Kramerica, Inc.
Kramerica Inc. just paid its investors a dividend of $2.00. This growing company expects dividends to
grow at 20% for the next 2 years. After year 2, dividends are expected to grow constantly at 5% per
year. Investors require a 15% return on Kramerica stock.
NARREND
52. What will be the dividend in two years for Kramerica?
a.
$2.21
b.
$2.40
c.
$2.52
d.
$2.88
53. What is the equation to price Kramerica stock?
a.
P0
b.
P0
c.
P0
d.
P0
ABC Corporation
ABC Corporation just paid a dividend of $1.50 a share. The dividend is expected to grow at 10% a
year for the next 2 years, and the 5% per year thereafter. The required return to invest in ABC stock is
12.50%.
NARREND
54. What is the expected dividend for ABC in year 2?
a.
$1.65
b.
$1.73
c.
$1.82
d.
$1.91
55. What is the intrinsic value (or current price) of ABC?
a.
$21.00
b.
$22.98
c.
$23.41
d.
$24.48
56. Suppose you want to buy ABC and hold it for the next 4 years. What would the selling price be for
ABC in 4 years, assuming that none of our assumptions change?
a.
$28.01
b.
$28.76
c.
$29.40
d.
$30.80
57. A stock just paid a $2.00 dividend this morning. You believe that dividends will grow constantly
starting today at a rate of 5% per year. If you require a 10% to own this stock, what is a fair price to
pay for the stock?
a.
$40.00
b.
$41.00
c.
$42.00
d.
$43.00
58. Suppose that you estimate D1=$0.72, D2=$0.76, D3=$0.84, and D4=$0.88 for a stock. You also
estimate that, beginning at year 4, dividends will grow continually at a rate of 2% per year. If the
required return to hold the stock is 14.6%, what is the stock’s current price?
a.
$6.20
b.
$6.25
c.
$6.30
d.
$6.40
59. Suppose you plan on buying a stock today and holding it for one year. The stock will pay you a
dividend EXACTLY in one year on the day you will sell. You believe the selling price in one year will
be $27.10, while the stock will also pay a dividend of $2.40 in one year. If you require 16.60% return
to invest in the stock, what is a fair price to pay today?
a.
$25.50
b.
$25.30