14) Baseheart, Inc. expects its current annual $2.50 per share common stock dividend to remain
the same for the foreseeable future. Therefore, the value of the stock to an investor with a
required return of 12% is:
A) $3.00
B) $18.33
C) $20.83
D) $30.00
15) Which of the following changes will make the value of a stock go up, other things being held
constant?
A) The required return decreases.
B) The required return increases.
C) In general, investors become more risk averse.
D) The growth rate of dividends decreases.
16) If two firms have the same current dividend and the same expected growth rate, their stocks
must sell at the same current price or else the market will not be in equilibrium.
A) False, because the required return could be different
B) True, because we are using a dividend valuation model
C) True if markets are semi-strong form efficient
D) True if investors are risk-averse
17) You are considering the purchase of a common stock that paid a dividend of $2.00 yesterday.
You expect this stock to have a growth rate of 15 percent for the next 3 years, resulting in
dividends of D1=$2.30, D2=$2.645, and D3=$3.04. The long-run normal growth rate after year 3
is expected to be 10 percent (that is, a constant growth rate after year 3 of 10% per year forever).
If you require a 14 percent rate of return, how much should you be willing to pay for this stock?
A) $89.75
B) $83.65
C) $56.46
D) $62.57
16
18) Which of the following statements concerning the required rate of return on stocks is true?
A) The higher an investor’s required rate of return, the higher the value of the stock.
B) If risk is reduced, the required return will decrease because more investors are risk-averse.
C) The required return on preferred stock is generally higher than the required return on common
stock.
D) The higher the risk, the higher the required return, other things being equal.
19) Which of the following statements concerning the constant growth dividend valuation model
is true?
A) The required rate of return must exceed the growth rate.
B) The dividend growth rate must be bigger than 8%.
C) The growth rate must increase every year.
D) The required rate of return must be equal to the growth rate for dividends.
20) A small biotechnology research corporation has been experiencing losses for the first three
years of its existence, and thus has a negative balance in retained earnings. The corporation’s
stock price, however, is $1 per share. Which of the following statements is most correct?
A) Investors are irrational to pay $1 per share when earnings per share have been negative for
three years.
B) Investors believe the stock is worth $1 per share because future earnings (and cash flows) are
expected to be positive.
C) The corporation’s accountants must have made a mistake because retained earnings may not
be negative.
D) The required return on the stock will be small because the company has very few assets.
21) A small company struggling to reach profitability just announced a major new government
contract that will validate its technology and generate revenue for the next several years. The
announcement of the contract will
A) cause the stock price to increase because rcs (the required return) is likely to increase.
B) cause the stock price to decrease because the government usually pays below market price for
the goods and services it purchases.
C) cause the stock price to increase because rcs (the required return) is likely to decrease and g
(the growth rate in future dividends) is likely to increase.
D) have no effect on the stock price because the company has not yet paid any dividends.
22) Using the constant growth dividend valuation model and assuming dividends will growth a
constant rate forever, the increase in the value of the stock each year should be equal to the
A) growth rate in dividends, g.
B) required return on the stock, rcs.
C) dividend yield plus the capital gains yield.
D) dividend yield.
23) Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the
foreseeable future. Therefore,
A) the stock will be valued at $0.50 times the number of years an investor plans to keep it.
B) the value of the stock can be estimated as $0.50 divided by an investor’s required rate of
return.
C) the value of the stock can not be determined using the dividend valuation model because the
growth rate is zero.
D) the value of the stock is positive only if the required return is negative
24) A financial analyst expects KacieCo. to pay a dividend of $2 per share one year from today,
a dividend of $3 per share in years two, and estimates the value of the stock at the end of year
two to be $22. If your required return on KacieCo stock is 14 %, what is the most you would be
willing to pay for the stock today if you plan to sell the stock in two years?
A) $20.99
B) $26.75
C) $26.90
D) $27.00
25) Kilsheimer Company just paid a dividend of $5 per share. Future dividends are expected to
grow at a constant rate of 7% per year. What is the value of the stock if the required return is
16%?
A) $33.44
B) $55.56
C) $59.44
D) $65.87
26) Emery Company just paid a dividend yesterday of $2.25 per share. The company’s stock is
currently selling for $60 per share, and the required rate of return on Emery Company stock is
16%. What is the growth rate expected for Emery Company dividends assuming constant
growth?
A) 9.47%
B) 9.89%
C) 10.87%
D) 11.81%
27) J&S Corporation has preferred stock which paid an annual dividend in 2009 of $5 per share.
J&S also has common stock which paid a dividend in 2009 of $5. Which of the following
statements is most correct concerning J&S stock?
A) The price of the preferred stock should equal the price of the common stock since the
dividends are the same.
B) The price of the common stock could be higher than the price of the preferred stock if the
common stock dividends are expected to grow in the future.
C) The price of the preferred stock is expected to be higher than the price of the common stock
because the required return on preferred stock is higher than the required return on common
stock.
D) If the required return on the preferred stock is the same as the required return on the common
stock, then the price of preferred stock should equal the price of the common stock if markets are
efficient.
28) Using the dividend valuation method, an analyst determines the value of Company A’s stock
to be $10 and the value of Company B’s stock to be $14. Based on this information, which of the
following statements is most accurate?
A) Company B must be riskier than Company A, and risk requires a reward.
B) Other things being equal, if Company A and Company B have the same firm value, Company
B must have more debt, thus leveraging its returns for the benefit of shareholders.
C) Other things being equal, if Company A and Company B have the same firm value, Company
A may have more shares of stock outstanding than Company B.
D) Company B’s required rate of return is higher than Company A’s required return.
29) All of the following affect the value of a share of common stock except:
A) the dollar amount of the dividends.
B) investors’ required rate of return.
C) the future growth rate for dividends.
D) the stock and paid-in-capital amounts on the balance sheet.
30) The PDQ Company’s common stock is expected to pay a $2.00 dividend in the coming year.
If investors require a 17% return and the growth rate in dividends is expected to be 8%, what will
the market price of the stock be?
A) $11.76
B) $24.00
C) $23.11
D) $22.22
31) An example of the growth factor in common stock is:
A) acquiring a loan to fund an investment in Asia.
B) retaining profits in order to reinvest into the firm.
C) issuing new stock to provide capital for future growth.
D) two strong companies merging together to increase their economy of scale.
32) You are considering the purchase of a share of Edie’s common stock. You expect to sell it at
the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year.
Edie just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most
you would be willing to pay for it now?
A) $28.57
B) $33.05
C) $20.83
D) $30.80
33) Lily Co. paid a dividend of $5.25 on its common stock yesterday. The company’s dividends
are expected to grow at a constant rate of 8.5% indefinitely. If the required rate of return on this
stock is 15.5%, compute the current value per share of Lily Co. stock.
A) $81.38
B) $76.43
C) $56.23
D) $43.90
34) Lily Co.paid a dividend of $5.25 on its common stock yesterday. The company’s dividends
are expected to grow at a constant rate of 8.5% indefinitely. The required rate of return on this
stock is 15.5%. You observe a market price of $78.50 for the stock. Should you purchase this
stock?
A) No, the market price is above the intrinsic value of the stock.
B) Yes, the market price is below the intrinsic value of the stock.
C) No, the growth rate in dividends is too far below the required return.
D) Yes, but only if you can keep the stock for at least 5 years.
35) Wallace Industries paid a dividend of $1.65 on its common stock yesterday. The dividends of
Wallace Industries are expected to grow at 9% per year indefinitely. If the risk free rate is 3%
and investors’ risk premium on this stock is 8%, estimate the value of Wallace Industries stock 2
years from now.
A) $106.84
B) $100.43
C) $91.81
D) $54.71
36) Greenland Airlines has net income of $2 million this year. The book value of Greenland
Airlines common equity is $8 million dollars. The company’s dividend payout ratio is 60% and is
expected to remain this way. What is Greenland Airlines’ internal growth rate?
A) 6%
B) 9%
C) 10%
D) 15%
37) Berberich Corporation net income this year is $800,000. The company generally retains 35%
of net income for reinvestment. The company’s common equity currently has a book value of
$5,000,000. They just paid a dividend of $1.37, and the required rate of return on this stock is
12%. Compute the value of this stock if dividends are expected to continue growing indefinitely
at the company’s internal growth rate.
A) $22.61
B) $11.42
C) $15.63
D) $4.35
38) Chambers Corporation’s ROE is 20%. Their dividend payout ratio is 70%. The last dividend,
just paid, was $2.00. If dividends are expected to grow by the company’s internal growth rate
indefinitely, what is the current value of Chambers common stock if its required return is 18%?
A) $17.67
B) $16.89
C) $14.92
D) $11.52
39) Johnstown Supply Corporation stock is currently selling for $58.00. It is expected to pay a
dividend of $5.00 at the end of the year. Dividends are expected to grow at a constant rate of
7.5% indefinitely. Compute the required rate of return on Johnstown Supply Corporation stock.
A) 12.48%
B) 15.65%
C) 13.64%
D) 16.12%
40) Modem Development, Inc. paid a dividend of $5.00 per share on its common stock
yesterday. Dividends are expected to grow at a constant rate of 4% for the next two years, at
which point the stock is expected to sell for $56.00. If investors require a rate of return on
Modem’s common stock of 18%, what should the stock sell for today?
A) $50.22
B) $48.51
C) $44.76
D) $40.22
41) If you expect NoDiv Corporation to sell for $75 per share in three years while paying no
dividends along the way, and if your required rate of return is 16% per year, how much is the
stock worth today?
A) $42.68
B) $48.05
C) $51.10
D) $74.64
42) Creamy Custard common stock is currently selling for $79.00. It just paid a dividend of
$4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is the required rate
of return on Creamy Custard’s stock?
A) 11.11%
B) 11.76%
C) 12.2%
D) 14.21%
43) Modem Development, Inc. paid a dividend of $5.00 per share on its common stock
yesterday. Dividends are expected to grow at a constant rate of 10% for the next two years, at
which point the dividends will begin to grow at a constant rate indefinitely. If the stock is selling
for $50 today and the required return is 15%, what it the expected annual dividend growth rate
after year two?
A) 3.365%
B) 3.878%
C) 4.556%
D) 5.000%
44) I Sage, whose common stock is currently selling for $12 per share, is expected to pay a $1.80
dividend, and sell for $14.40 one year from now. What are the dividend yield, growth rate, and
total rate of return, respectively?
A) 15% 20% 35%
B) 10%5%15%
C) 15% 12% 27%
D) 20% 15% 35%
45) Shara Miselle Co. just paid a dividend of $1.65 (D0) on its common stock. This company’s
dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate of return
on this stock is 11%, compute the current value per share of Shara Miselle stock.
A) $20.63
B) $21.24
C) $15.00
D) $55.00
46) You observe Golden Flashes Common Stock selling for $40.00 per share. The next dividend
is expected to be $4.00, and is expected to grow at a 5% annual rate forever. If your required rate
of return is 12%, should you purchase the stock?
A) Yes, because the present value of the expected future cash flows is greater than $40.
B) No, because the present value of the expected future cash flows is less than $40.
C) Yes, because the present value of the expected future cash flows is less than $40.
D) No, because the present value of the expected future cash flows is greater than $40.
47) NewAge, Inc. paid a dividend yesterday of $2 per share. NewAge management expects the
dividend to increase next year to $3 annually. If the dividend is expected to stay at $3 per year
for the foreseeable future, what is the value of the stock to an investor with a required rate of
return of 10%?
A) $7.50
B) $30.00
C) $32.00
D) $50.00
48) H. J. Corp.’s common stock paid $2.50 in dividends last year (D0). Dividends are expected to
grow at a 12-percent annual rate forever. If H. J.’s current market price is $40.00, and your
required rate of return is 23 percent, should you purchase the stock?
A) No, the percentage return on the stock is too high, thus it is too risky.
B) Yes, the stock is expected to return more than you require.
C) No, the stock is overpriced.
D) Not enough information is given.
49) Diana Ltd. paid a $2.50 per share dividend yesterday. The dividend is expected to grow at
10 percent per year for the foreseeable future. Diana Ltd. has a beta of 1.6, a standard deviation
of returns of 30 percent, and a required return of 18%. What is the value of a share of Diana Ltd.
common stock?
50) You are considering the purchase of Zee Company stock. You anticipate that the company
will pay dividends of $3.50 per share next year and $4.00 per share the following year. You
believe that you can sell the stock for $20.00 per share two years from now. If your required rate
of return is 10 percent, what is the maximum price that you would pay for a share of Zee
Company stock?
51) The price of DDS Corporation stock is expected to be $45 in 5 years. Dividends are
anticipated to increase at an annual rate of 10 percent from the most recent dividend of $1.00. If
your required rate of return is 15 percent, how much are you willing to pay for DDS stock?
8.5 Learning Objective 5
1) The expected rate of return implied by a given market price equals the required rate of return
for investors at the margin.
2) Butler Corp paid a dividend today of $5 per share. The dividend is expected to grow at a
constant rate of 6.5% per year. If Butler Corp stock is selling for $50.00 per share, the
stockholders’ expected rate of return is
A) 11.50%.
B) 13.56%.
C) 15.49%.
D) 16.50%.
3) The expected rate of return on a share of common stock whose dividends are growing at a
constant rate (g) is which of the following, where D1 is the next dividend and Vc is the current
value of the stock?
A) (D1 + g)/Vc
B) D1/Vc + g
C) D1/g
D) D1/g + Vc
4) Bin Restaurant Corp preferred stock has a market price of $14.50. If it has a yearly dividend
of $3.50, what is your expected rate of return if you purchase the stock at its market price?
A) 41.43%
B) 19.45%
C) 22.36%
D) 24.14%
5) ADR Bank preferred stock pays an annual dividend of $2.75 per share. If the stock is
currently selling for $27.50 per share, what is the expected rate of return on this stock?
A) 2.75%
B) 10.0%
C) 17.5%
D) 27.5%
6) H. J. Corp. common stock paid $2.50 in dividends last year (D0). Dividends are expected to
grow at a 12-percent annual rate forever. If H. J.’s current market price is $40.00, what is the
stock’s expected rate of return (nearest .01 percent)?
A) 5.50%
B) 11.00%
C) 18.25%
D) 19.00%
7) U.S Technologies preferred stock sells for $80 and pays $9 each year in dividends. What is
the expected rate of return?
8) You purchased one share of Sophia Enterprises common stock for $30 today. If the stock pays
a dividend of $6.50 in one year, and sells for $32.50 at that time, what will the dividend yield,
growth rate, and total rate of return be for the year?
9) Tannerly Worldwide’s common stock is currently selling for $48 a share. If the expected
dividend at the end of the year is $2.40 and last year’s dividend was $2.00, what is the rate of
return implicit in the current stock price?
10) Miller’s preferred stock is selling at $54 on the market and pays an annual dividend of $4.20
per share.
a. What is the expected rate of return on the stock?
b. If an investor’s required rate of return is 9%, what is the value of the stock to that investor?
c. Considering the investor’s required rate of return, does this stock seem to be a desirable
investment?
11) The common stock of Cranberry Inc. is selling for $26.75 on the open market. Next year’s
dividend is expected to be $3.68, and the growth rate of this company is estimated to be 5.5%. If
Richard Dean, an average investor, is considering purchasing this stock at the market price, what
is his expected rate of return?