Chapter 08 – Valuing Stocks
CHAPTER 8 – VALUING STOCKS
Questions
LG1 1. As owners, what rights and advantages do shareholders obtain?
LG1 2. Describe how being a residual claimant can be very valuable.
LG2 3. Obtain a current quote of McDonald’s (MCD) from the Internet. Describe what has changed
since the quote in Figure 8.1.
LG2 4. Get the trading statistics for the three main U.S. stock exchanges. Compare the trading
activity to that of Table 8.1.
Chapter 08 – Valuing Stocks
ADVANCES & DECLINES
NYSE AMEX NASDAQ
Advancing Issues 2,485 (61%) 394 (58%) 1,714 (63%)
LG3 5. Why might the Standard & Poor’s 500 Index be a better measure of stock market performance
than the Dow Jones Industrial Average? Why is the DJIA more popular than the S&P 500?
LG3 6. Explain how it is possible for the DJIA to increase one day while the Nasdaq Composite
decreases during the same day.
Chapter 08 – Valuing Stocks
LG4 7. Which is higher, the ask quote or the bid quote? Why?
LG4 8. Illustrate through examples how trading commission costs impact an investor’s return.
LG4 9. Describe the difference in the timing of trade execution and the certainty of trade price
between market orders and limit orders.
LG5 10. What are the differences between common stock and preferred stock?
LG5 11. How important is growth to a stock’s value? Illustrate with examples.
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Chapter 08 – Valuing Stocks
LG5 12. Under what conditions would the constant growth rate model not be appropriate?
LG5 13. The expected return derived from the constant growth rate model relies on dividend yield and
capital gain. Where do these two parts of the return come from?
LG6 14. Describe, in words, how to use the variable growth rate technique to value a stock.
LG6 15. Can the variable growth rate model be used to value a firm that has a negative growth rate in
Stage 1 and a stable and positive growth rate in Stage 2? Explain.
LG7 16. Explain why using the P/E relative value approach may be useful for companies that do not
pay dividends.
Chapter 08 – Valuing Stocks
LG7 17. How is a firm’s changing P/E ratio reflected in the stock price? Give examples.
LG7 18. Differentiate the characteristics of growth stocks and value stocks?
LG7 19. What’s the relationship between the P/E ratio and a firm’s growth rate?
LG7 20. Describe the process for using the P/E ratio to estimate a future stock price.
Problems
Basic Problems
LG3 8-1 Stock Index Performance On March 5, 2013, the Dow Jones Industrial Average
set a new high. The index closed at 14,253.77, which was up 125.95 that day. What was the
return (in percent) of the stock market that day?
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Chapter 08 – Valuing Stocks
LG3 8-2 Stock Index Performance On March 9, 2009, the Dow Jones Industrial Average reached a
new low. The index closed at 6,547.05, which was down 79.89 that day. What was the return (in
percent) of the stock market that day?
LG4 8-3 Buying Stock with Commissions At your discount brokerage firm, it costs $7.95 per stock
trade. How much money do you need to buy 200 shares of Pfizer, Inc. (PFE), which trades at
$31.40?
LG4 8-4 Buying Stock with Commissions At your discount brokerage firm, it costs $9.50 per stock
trade. How much money do you need to buy 300 shares of Time Warner, Inc. (TWX), which
trades at $22.62?
LG4 8-5 Selling Stock with Commissions At your full-service brokerage firm, it costs $140 per stock
trade. How much money do you receive after selling 200 shares of Nokia Corporation (NOK),
LG4 8-6 Selling Stock with Commissions At your full-service brokerage firm, it costs $135 per stock
trade. How much money do you receive after selling 250 shares of International Business
Machines (IBM), which trades at $96.17?
LG4 8-7 Buying Stock with a Market Order You would like to buy shares of Sirius Satellite Radio
(SIRI). The current ask and bid quotes are $3.96 and $3.93, respectively. You place a market
LG4 8-8 Buying Stock with a Market Order You would like to buy shares of Coldwater Creek, Inc.
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Chapter 08 – Valuing Stocks
LG4 8-9 Selling Stock with a Limit Order You would like to sell 200 shares of Xenith Bankshares
(XBKS). The current ask and bid quotes are $4.66 and $4.62, respectively. You place a limit
sell-order at $4.65. If the trade executes, how much money do you receive from the buyer?
LG4 8-10 Selling Stock with a Limit Order You would like to sell 100 shares of Echo Global
Logistics, Inc. (ECHO). The current ask and bid quotes are $15.33 and $15.28, respectively. You
place a limit sell-order at $15.31. If the trade executes, how much money do you receive from
LG5 8-11 Value of a Preferred Stock A preferred stock from Duquesne Light Company (DQUPRA)
pays $3.55 in annual dividends. If the required return on the preferred stock is 6.7 percent,
what’s the value of the stock?
Chapter 08 – Valuing Stocks
Chapter 08 – Valuing Stocks