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Chapter 08: Basic Stock Valuation
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Page 21
a.
$13.72
b.
$14.44
c.
$15.20
d.
$16.00
e.
$16.80
ANSWER:
d
35. Huxley Building Supplies' last free cash flow was $1.75 million. Its free cash flow growth rate is expected to be
constant at 25% for 2 years, after which free cash flows are expected to grow at a rate of 6% forever. Its weighted average
cost of capital WACC is 12%. Huxley has $5 million in short-term investments and $7 million in debt and has 1 million
shares outstanding. What is the best estimate of the current intrinsic stock price?
a.
$39.58
b.
$40.64
c.
$41.71
d.
$42.80
Chapter 08: Basic Stock Valuation
e.
$44.92
POINTS:
1
36. Atchley Corporation’s last free cash flow was $1.55 million. The free cash flow growth rate is expected to be constant
at 1.5% for 2 years, after which free cash flows are expected to grow at a rate of 8.0% forever. The firm's weighted
average cost of capital (WACC) is 12.0%. Atchley has $2 million in short-term debt and $14 million in debt and 1 million
shares outstanding. What is the best estimate of the intrinsic stock price?
a.
$25.05
b.
$26.16
c.
$27.30
d.
$28.48
e.
$29.70
ANSWER:
a
POINTS:
1
37. The free cash flows (in millions) shown below are forecast by Simmons Inc. If the weighted average cost of capital is
13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what
is the Year 0 value of operations, in millions?
Year:
1
2
3
Free cash flow:
−$20
$42
$45
a.
$586
b.
$617
c.
$648
d.
$680
e.
$714
ANSWER:
b
38. Free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.
a.
True
b.
False
ANSWER:
True
39. The expected 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
ANSWER:
False
40. The constant growth dividend 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
ANSWER:
True
41. Which of the following statements is CORRECT?
a.
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%.
b.
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.
c.
The price of a stock is the present value of all expected future dividends, discounted at the dividend growth
rate.
d.
The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain
constant over time.
e.
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.
ANSWER:
b
42. If a firm's expected growth rate increased then its required rate of return would
a.
decrease.
b.
fluctuate less than before.
c.
fluctuate more than before.
d.
possibly increase, possibly decrease, or possibly remain constant.
e.
increase.
ANSWER:
d
43. You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think
a.
the stock should be sold.
b.
the stock is a good buy.
c.
management is probably not trying to maximize the price per share.
d.
dividends are not likely to be declared.
e.
the stock is experiencing supernormal growth.
ANSWER:
b
44. Which of the following statements is CORRECT?
a.
Two firms with the same expected dividend and growth rates must also have the same stock price.
b.
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.
c.
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%.
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 takes into consideration the capital gains investors expect to earn on a stock.
ANSWER:
e
45. 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 dividend yield 5 years from now is expected to be 10%.
b.
The constant growth model cannot be used because the growth rate is negative.
c.
The company's expected capital gains yield is 5%.
d.
The company's expected stock price at the beginning of next year is $9.50.
e.
The company's current stock price is $20.
ANSWER:
d
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46. 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 stock's dividend yield is 5%.
b.
The price of the stock is expected to decline in the future.
c.
The stock's required return must be equal to or less than 5%.
d.
The stock's price one year from now is expected to be 5% above the current price.
e.
The expected return on the stock is 5% a year.
ANSWER:
d
47. 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
Required return
10%
12%
Market price
$25
$40
Expected growth
7%
9%
a.
These two stocks must have the same dividend yield.
b.
These two stocks should have the same expected return.
Chapter 08: Basic Stock Valuation
c.
These two stocks must have the same expected capital gains yield.
d.
These two stocks must have the same expected year-end dividend.
e.
These two stocks should have the same price.
ANSWER:
a
48. 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 could not be in equilibrium with the numbers given in the question.
b.
A's expected dividend is $0.50.
c.
B's expected dividend is $0.75.
d.
A's expected dividend is $0.75 and B's expected dividend is $1.20.
e.
The two stocks should have the same expected dividend.
ANSWER:
d
49. 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
$25
Expected growth (constant)
10%
5%
Required return
15%
15%
a.
Stock A has a higher dividend yield than Stock B.
b.
Currently the two stocks have the same price, but over time Stock B's price will pass that of A.
c.
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.
d.
The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
e.
Stock A's expected dividend at t = 1 is only half that of Stock B.
ANSWER:
e
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50. 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 Y has a higher dividend yield than Stock X.
b.
One year from now, Stock X's price is expected to be higher than Stock Y's price.
c.
Stock X has the higher expected year-end dividend.
d.
Stock Y has a higher capital gains yield.
e.
Stock X has a higher dividend yield than Stock Y.
ANSWER:
b
51. 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 expected dividend yield and growth rate are equal.
b.
The stock's expected dividend yield is 5%.
c.
The stock's expected capital gains yield is 5%.
d.
The stock's expected price 10 years from now is $100.00.
e.
The stock's required return is 10%.
Chapter 08: Basic Stock Valuation
POINTS:
1
52. 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 X pays a higher dividend per share than Stock Y.
b.
One year from now, Stock X should have the higher price.
c.
Stock Y has a lower expected growth rate than Stock X.
d.
Stock Y has the higher expected capital gains yield.
e.
Stock Y pays a higher dividend per share than Stock X.
ANSWER:
a
53. Merrell Enterprises' stock has an expected return of 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 8%.
b.
The current dividend per share is $4.00.
c.
The stock price is expected to be $54 a share one year from now.
d.
The stock price is expected to be $57 a share one year from now.
e.
The stock's dividend yield is 7%.
ANSWER:
c
54. 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.
Stock B must have a higher dividend yield than Stock A.
b.
Stock A must have a higher dividend yield than Stock B.
c.
If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock
B's.
d.
Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
e.
If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock
B's.
ANSWER:
e
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55. 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.
If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
b.
If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
c.
The two stocks must have the same dividend growth rate.
d.
The two stocks must have the same dividend yield.
e.
The two stocks must have the same dividend per share.
ANSWER:
a
56. Which of the following statements is CORRECT, assuming stocks are in equilibrium?
a.
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.
b.
A stock's dividend yield can never exceed its expected growth rate.
c.
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.
d.
Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.
Chapter 08: Basic Stock Valuation
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e.
The dividend yield on a constant growth stock must equal its expected total return minus its expected capital
gains yield.
ANSWER:
e
57. Which of the following statements is CORRECT?
a.
The preferred stock of a given firm is generally less risky to investors than the same firm's common stock.
b.
Corporations cannot buy the preferred stocks of other corporations.
c.
Preferred dividends are not generally cumulative.
d.
A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing
corporation.
e.
Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to
the proceeds in a liquidation.
ANSWER:
a
58. Which of the following statements is CORRECT?
a.
Preferred stock is normally expected to provide steadier, more reliable income to investors than the same
Chapter 08: Basic Stock Valuation
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.
b.
The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to
purchase (on a pro rata basis) new issues of preferred stock.
c.
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.
d.
One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax
deductible to the issuer.
e.
A major disadvantage of financing with preferred stock is that preferred stockholders typically have
supernormal voting rights.
ANSWER:
a
59. Which of the following statements is CORRECT?
a.
The preemptive right gives stockholders the right to approve or disapprove of a merger between their company
and some other company.
b.
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.
c.
The stock valuation model, P0 = D1/(rs − g), cannot be used for firms that have negative growth rates.
d.
The stock valuation model, P0 = D1/(rs − g), can be used only for firms whose growth rates exceed their
required returns.
e.
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.
ANSWER:
b
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60. The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is
CORRECT?
a.
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.
b.
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.
c.
The stocks must sell for the same price.
d.
Stock Y must have a higher dividend yield than Stock X.
e.
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.
ANSWER:
e
61. 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%
Chapter 08: Basic Stock Valuation
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Page 38
a.
Stock A must have a higher dividend yield than Stock B.
b.
Stock B's dividend yield equals its expected dividend growth rate.
c.
Stock B must have the higher required return.
d.
Stock B could have the higher expected return.
e.
Stock A must have a higher stock price than Stock B.
POINTS:
1
62. 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
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POINTS:
1
63. A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g
= 4.0%. What is the current stock price?
a.
$23.11
b.
$23.70
c.
$24.31
d.
$24.93
e.
$25.57
POINTS:
1
64. A share of Lash Inc.'s common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock
Chapter 08: Basic Stock Valuation
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Page 40
is 5.4%, and if investors' required rate of return is 11.4%, what is the stock price?
a.
$16.28
b.
$16.70
c.
$17.13
d.
$17.57
e.
$18.01
ANSWER:
d
65. Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock
sells for $32.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate,
g, forever. What is the equilibrium expected growth rate?
a.
6.01%
b.
6.17%
c.
6.33%
d.
6.49%
e.
6.65%
ANSWER:
e
Growth rate = rs − D1/P0 =
6.65%
POINTS:
1
