99. What price would an individual be willing to pay today for a stock that is expected to sell
for $100 two years from now and which pays an annual dividend that is $6.00? Assume the
individual has a discount rate of 8% (0.08).
100. What price would an individual would be willing to pay for a stock that currently pays a
$5.00 annual dividend if the individual expects the dividend to grow by 4% (0.04) per year and
the individual has a discount rate of 6.0% (0.06)?
101. After one year, a company will pay $20 in dividends. It commits to paying $21 two years from
the current date. This growth rate in dividends is expected to continue indefinitely. The interest rate
is 8%. Compute the current price of this stock, using the dividend-discount model.
102. Identify the ways in which a bondholder’s rights differ from those of a stockholder. In what
ways do they differ when a firm is bankrupt?
103. This is a two-part question: We have a firm that needs $1000 to obtain a new machine for
its business. It can either issue stock or bonds, or some combination of both. If it issues bonds it
will have to pay $8.00 in interest for every $100 borrowed. Finally, assume the company will
earn $150 in good years and $75 in bad years, with equal probability. The first part of the
question is to (a) determine the payment to the equity holders under the following three
scenarios: (i) the first is the firm uses 0% debt financing; (ii) the second is the firm uses 50%
debt financing, and (iii) the third finds the firm using 80% debt financing.
The second part of the question is to (b) determine the expected equity return (%) under each
scenario.
104. You make a $1,000 investment in the stock of ABC Inc. Over the next year the investment
decreases by 60%. What percentage increase do you need in the following year on your holding
to be back to $1,000?
105. The investment you made in a mutual fund one year ago lost 50% of its value over the past
year. What percentage increase is needed in the fund to restore your portfolio to the level it was
one year ago?
106. After one year, a company will pay $5 in dividends. It commits to paying $5.30 two years
from the current date. This growth rate for dividends is expected to continue indefinitely. The
U.S. Treasury bond yield is 8% and the equity–risk premium is equal to 2.5%. Compute the
required stock return and current price of this stock, using the dividend-discount model.
107. Considering the return an investor requires from a stock, what are the two components that
make up that return? Briefly explain each of these components.
108. Discuss the effects on the current price of a stock from each of the following:
a) An increase in the growth rate of the dividend;
b) A decrease in the risk-free interest rate;
c) An increase in the equity-risk premium; and finally
d) A decrease in the annual dividend.
109. Why does the theory of efficient markets imply that stock price movements are
unpredictable?
110. Is the efficient markets hypothesis (EMH) responsible for the financial crisis of 2007-
2009?
111. What possibilities exist to explain the claim made by many professional portfolio
managers that they can exceed the average stock market return year after year?
112. From the perspective of the theory of efficient markets, explain why it may be difficult for
professional portfolio managers who have an exceptional year to continuously outperform the
market average.
113. You hear someone claim that stocks are less risky than bonds. What possible evidence
could this person offer for such a claim?
114. Use the five issues an investor should consider when purchasing stock to explain the
popularity of mutual funds.
115. Explain how a well-functioning stock market contributes to the efficiency of the economy.
116. Identify at least two reasons an investor may want to consider an index fund over a managed
(mutual) fund. What are these reasons?
117. Discuss the inefficiencies that can be caused by stock market bubbles, especially focusing
on firms and consumers.
Essay Questions
118. Do the voting rights possessed by common stockholders ensure that managers and directors
have the same objectives as stockholders? Explain.
39
119. If you understood the discussion of the characteristics of common stocks, you should be
able to explain the following statement: One of the benefits from stock ownership is the
unlimited upside potential and the limited downside. What does this statement mean?
120. XYZ Inc. announces plans to finance the expansion of the firm by issuing hundreds of
millions of dollars of bonds. Discuss how the current stockholders of XYZ Inc. will feel about
this plan.
121. Discuss how changes in economic conditions are likely to affect the equity-risk premium
and stock prices. Considering the risks associated with investing in stocks (over short periods of
time), what types of investments would you expect investors to buy during an economic
recession?
122. You are a top Treasury official for a developing country who has been asked
for advice on how to best open the nation’s stock market to foreign investment.
Previously, the government did not permit foreigners to purchase domestic stock.
Now, the government has a plan to create two markets: one for domestic residents
and one for foreign investment. What are the potential drawbacks of this system,
compared to allowing both domestic and foreign investors to trade in the same
market? What are the larger implications for economic efficiency? How might the
government be able to address these issues?
123. Discuss whether the economy would be more or less efficient if public
corporations issued fewer shares of stock.
