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?
Table 7.1
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?
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