FIN 100 Principles of Finance part 3

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

4) Common stockholders are essentially:

1. A) creditors of the firm.
2. B) managers of the firm.
3. C) owners of the firm.
4. D) all of the above.

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: voting rights

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Butler, Inc.'s return on equity is 17% and management retains 75% of earnings for investment purposes. Based on this information, what will be the firm's growth rate?

4. A) 4.25%
5. B) 22.67%
6. C) 44.12%
7. D) 12.75%

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

6) If a company has a return on equity of 25% and wants a growth rate of 10%, how much of ROE should be retained?

1. A) 40%
2. B) 50%
3. C) 60%
4. D) 70%

Answer: A

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

7) ________ gives minority shareholders more power to elect board of directors.

1. A) Preemptive right
2. B) Majority voting
3. C) Proxy fights
4. D) Cumulative voting

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: voting rights

Principles: Principle 4: Market Prices Reflect Information

8) You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected dividends. Round to the nearest $0.10.

4. A) $4.90
5. B) $11.50
6. C) $9.80
7. D) $6.10

Answer: A

Diff: 2

Topic: 10.1 Common Stock

Keywords: agency

Principles: Principle 3: Cash Flows Are the Source of Value

9) You are evaluating the purchase of Holdings, Inc. common stock that just paid a dividend of $1.80, and the dividend will be $1.80 per share per year for the next ten years. You plan to hold the stock for three years and then sell it. You expect the price of the company's stock to rise to $51.50 at the end of your three-year holding period. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected future stock price. Round to the nearest $.25.

64. A) $64.00
65. B) $55.25
66. C) $31.75
67. D) $103.00

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

10) CEO naming friends to the board of directors and paying them more than the norm is an example of the:

1. A) agency problem.
2. B) preemptive right.
3. C) majority voting feature.
4. D) proxy fights.

Answer: A

Diff: 2

Topic: 10.1 Common Stock

Keywords: agency

Principles: Principle 4: Market Prices Reflect Information

11) Little Feet Shoe Co. just paid a dividend of $1.65 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 of per share of LFS stock.

20. A) $20.63
21. B) $21.24
22. C) $15.00
23. D) $55.00

Answer: B

Diff: 1

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

12) Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year. You expect the stock to grow at 5% per year. If the appropriate rate of return on this stock is 12%, how much are you willing to pay for the stock today?

13. A) $13.00
14. B) $15.00
15. C) $17.00
16. D) $19.00

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

13) Marble Corporation's ROE is 17%. Their dividend payout ratio is 20%. The last dividend, just paid, was $2.58. If dividends are expected to grow by the company's sustainable growth rate indefinitely, what is the current value of Marble common stock if its required return is 18%?

14. A) $14.33
15. B) $18.27
16. C) $47.67
17. D) $66.61

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

14) Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely. Compute the required rate of return on FBC stock.

1. A) 10%
2. B) 33%
3. C) 7%
4. D) 4.3%

Answer: A

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

15) You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01.

36. A) $36.65
37. B) $91.23
38. C) $51.55
39. D) $74.82

Answer: A

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

16) A stock currently sells for $63 per share, and the required return on the stock is 10%. Assuming a growth rate of 5%, calculate the stock's last dividend paid.

1. A) $1
2. B) $3
3. C) $5
4. D) $7

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

17) A decrease in the ________ will cause an increase in common stock value.

1. A) growth rate
2. B) required rate of return
3. C) last paid dividend
4. D) both B and C

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

18) Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as dividends, then we would expect the common shareholders' investment in the firm and the value of the common stock to grow by:

4. A) 4.80%.
5. B) 7.20%.
6. C) 12%.
7. D) 6%.

Answer: A

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

19) An investor is contemplating the purchase of common stock at the beginning of this year and to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end price for the stock of $40. If this investor's required rate of return is 10%, then the value of the stock to this investor is:

36. A) $36.36.
37. B) $38.18.
38. C) $33.06.
39. D) $34.88.

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

20) A firm just paid $2.00 on its common stock and expects to continue paying dividends, which are expected to grow 5% each year, from now to infinity. If the required rate of return for this stock is 9%, then the value of the stock is:

50. A) $50.00.
51. B) $40.00.
52. C) $54.50.
53. D) $52.50.

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

21) An issue of common stock currently sells for $40.00 per share, has an expected dividend to be paid at the end of the year of $2.00 per share, and has an expected growth rate to infinity of 5% per year. The expected rate of return on this security is:

1. A) 5%.
2. B) 10.25%.
3. C) 13.11%.
4. D) 10%.

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

22) White Sink, Inc. just paid a dividend of $5.55 per share on its common stock, and the firm is expected to generate constant growth of 12.25% over the foreseeable future. The common stock is currently selling for $73.75 per share. The firm's dividend payout ratio is 40%, and White's marginal tax rate is 40%. What is the rate of return that common stockholders expect? Round to the nearest 0.1%.

8. A) 8.5%
9. B) 20.7%
10. C) 15.5%
11. D) 4.8%

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

23) KDP's most recent dividend was $2.00 per share and is selling today in the market for $70. The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the market return is 10% on investments with comparable risk, should you purchase the stock?

1. A) No, because the stock is overpriced $1.33.
2. B) No, because the stock is overpriced $3.33.
3. C) Yes, because the stock is underpriced $1.33.
4. D) Yes, because the stock is underpriced $3.33.

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

24) An issue of common stock currently sells for $50.00 per share, has an expected dividend to be paid at the end of the year of $2.50 per share, and has an expected growth rate to infinity of 5% per year. If investors' required rate of return for this particular security is 12% per year, then this security is:

1. A) overvalued and offering an expected return higher than the required return.
2. B) undervalued and offering an expected return higher than the required return.
3. C) overvalued and offering an expected return lower than the required return.
4. D) undervalued and offering an expected return lower than the required return.

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

25) You are considering the purchase of Miller Manufacturing, Inc.'s common stock. The stock is selling for $21.00 per share. The next dividend is expected to be $2.10, and you expect the dividend to keep growing at a constant rate. If the stock is returning 15%, calculate the growth rate of dividends.

1. A) 3%
2. B) 5%
3. C) 8%
4. D) 10%

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

26) ABC, Inc. just paid a dividend of $2. ABC expects dividends to grow at 10%. The return on stocks like ABC, Inc. is typically around 12%. What is the most you would pay for a share of ABC stock?

1. A) $100
2. B) $110
3. C) $120
4. D) $130

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

27) Marjen, Inc. just paid a dividend of $5. Marjen stock currently sells for $73.57. The return on stocks like Marjen, Inc. is around 10%. What is the implied growth rate of dividends.

1. A) 1%
2. B) 3%
3. C) 5%
4. D) 7%

Answer: B

Diff: 3

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

28) Which investor incurs the greatest risk?

1. A) Mortgage bondholder
2. B) Preferred stockholder
3. C) Common stockholder
4. D) Debenture bondholder

Answer: C

Diff: 1

Topic: 10.1 Common Stock

Keywords: market required yield

Principles: Principle 2: There Is a Risk-Return Tradeoff

29) What allows common stockholders the right to cast a number of votes equal to the number of directors being elected?

1. A) The majority voting provision
2. B) The casting feature
3. C) The cumulative voting provision
4. D) The proxy method

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: voting rights

Principles: Principle 4: Market Prices Reflect Information

30) The shareholder can cast all votes for a single candidate or split them among various candidates through:

1. A) proxy fights.
2. B) cumulative voting.
3. C) call provisions.
4. D) majority voting.

Answer: B

Diff: 2

Topic: 10.1 Common Stock

Keywords: voting rights

Principles: Principle 4: Market Prices Reflect Information

31) You are considering the purchase of common stock that just paid a dividend of $6.50 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 18%. How much should you expect to pay for this stock?

1. A) $86
2. B) $94
3. C) $108
4. D) $121
5. E) $242

Answer: D

Diff: 1

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 4: Market Prices Reflect Information

32) You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share. The stock is selling for $115 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the expected dividends be worth today?

12. A) $12.60
13. B) $9.21
14. C) $17.12
15. D) $15.55
16. E) $11.46

Answer: E

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

33) A share of common stock just paid a dividend of $3.25 per share. The expected long-run growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the price of the stock be?

57. A) $57.51
58. B) $62.25
59. C) $71.86
60. D) $63.92
61. E) $44.94

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

34) Common stockholders expect greater returns than bondholders because:

1. A) they have no legal right to receive dividends.
2. B) they bear greater risk.
3. C) in the event of liquidation, they are only entitled to receive any cash that is left after all creditors are paid.
4. D) all of the above.

Answer: D

Diff: 2

Topic: 10.1 Common Stock

Keywords: NYSE

Principles: Principle 2: There Is a Risk-Return Tradeoff

35) WSU Inc. is a young company that does not yet pay a dividend. You believe that the company will begin to pay dividends 5 years from now, and that the company will then be worth $50 per share. If your required rate of return on this risky stock is 20%, what is the stock worth today?

1. A) $40
2. B) $10
3. C) $20.09
4. D) $0.00

Answer: C

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

36) Common stockholders are essentially creditors of the firm.

Answer: FALSE

Diff: 1

Topic: 10.1 Common Stock

Keywords: market required yield

Principles: Principle 2: There Is a Risk-Return Tradeoff

37) Common stock represents a claim on residual income.

Answer: TRUE

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

38) The growth rate of future earnings is determined by return on equity and the profit-retention rate.

Answer: TRUE

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

39) The stockholder's expected rate of return consists of a dividend yield and interest.

Answer: FALSE

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

40) When bankruptcy occurs, the claims of the common shareholders may go unsatisfied.

Answer: TRUE

Diff: 2

Topic: 10.1 Common Stock

Keywords: NYSE

Principles: Principle 2: There Is a Risk-Return Tradeoff

41) Cumulative voting gives each share of stock a number of votes equal to the number of directors being elected to the board.

Answer: TRUE

Diff: 2

Topic: 10.1 Common Stock

Keywords: voting rights

Principles: Principle 4: Market Prices Reflect Information

42) The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

Answer: TRUE

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

43) Stock valuation is more precise than bond valuation as stock cash flows are more certain.

Answer: FALSE

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

44) The stock valuation model D1/(Rc - g) requires Rc > G.

Answer: TRUE

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

45) Is the following common stock priced correctly? If no, what is the correct price?

Price = $26.25

Required rate of return = 13%

Dividend year 0 = $2.00

Dividend year 1 = $2.10

Answer: Growth rate = = 5%

Vcs = 2.10 = $26.25

.13 - .05

The stock is priced correctly.

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 3: Cash Flows Are the Source of Value

46) The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of $3.68 is expected to be distributed, 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?

Answer: R = (D/V) + g

R = ($3.68/$26.75) + .055

R = 19.26%

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

47) 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?

Answer: Rc = 2.40/48 + (2.40 - 2.00)/2.00

= .05 + .20

= 25%

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

48) Draper Company's common stock paid a dividend last year of $3.70. You believe that the long-term growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how much are you willing to pay for the stock?

Answer: P0 = = = $66.60

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

49) Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.

Answer: Kcs = + 5% = 10% + 5% = 15%

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

50) You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX Company stock?

Answer:

Vc = $2.00 PVIF12%,1 + $19.75 PVIF12%,2

= ($2.00)(.893) + ($19.75)(.797)

= $17.53

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

51) You can purchase one share of Sumter Company common stock for $80 today. You expect the price of the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?

Answer: $80.00 = +

$80.00 (1 + R) = $88.00

(1 + R) = = $1.10

R = .10

Diff: 2

Topic: 10.1 Common Stock

Keywords: dividend growth

Principles: Principle 1: Money Has a Time Value

10.2 The Comparables Approach to Valuing Common Stock

1) If a stock has a much higher than normal P/E ratio, investors probably expect:

1. A) slow growth in earnings.
2. B) rapid growth in earnings.
3. C) large increases in the price of the stock.
4. D) a declining stock price

Answer: B

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

2) Which of the following factors will influence a firm's P/E ratio?

1. A) The investors' required rate of return
2. B) Firm investment opportunities
3. C) General market conditions
4. D) All of the above

Answer: D

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

3) The P/E ratio is calculated by dividing:

1. A) the current stock price by stockholders' equity.
2. B) total assets by net income.
3. C) the current stock price by earnings per share.
4. D) the current stock price by operating cash flow per share.

Answer: C

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

4) The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at:

28. A) $28.20.
29. B) $26.25.
30. C) $27.23.
31. D) $8.57.

Answer: A

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

5) The retail analyst at Morgan-Sachs values stock of the GAP at $28.00 per share. They are using the average industry P/E ratio of 15. Their forecasted earnings per share for next year is:

1. A) $0.54.
2. B) $1.50.
3. C) $1.87.
4. D) There is not enough information calculate earnings per share.

Answer: C

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

6) Home Depot stock is currently selling for $30 per share. Next year's dividend is expected to be $1.00; next year's earnings per share are expected to be $2.14. Home Depot's P/E ratio is:

7. A) .07.
8. B) 14.
9. C) 2.14.
10. D) 30.

Answer: B

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

7) McDonald's stock currently sells for $77.50. It's expected earnings per share are $4.50. The average P/E ratio for the industry is 23.3. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, it's stock price would:

1. A) stay about the same.
2. B) rise.
3. C) fall.
4. D) there is not enough information.

Answer: B

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

8) If the ROE on a new investment is less than the firm's required rate of return:

1. A) the investment increases the firm's value.
2. B) the investment leaves the firm's value unchanged.
3. C) the effect on the firm's value is unpredictable.
4. D) the investment reduces the firm's value.

Answer: D

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

9) Zorba's is a small chain of of restaurants whose stock is not publicly traded. The average P/E ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's earnings were $1.10 per share; next's earnings are expected to be $1.21 per share. A reasonable price for a share of Zorba's stock is:

19. A) $19.97.
20. B) $18.15.
21. C) $20.23.
22. D) $16.72.

Answer: A

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

10) Apple stock is now selling for $315.32 per share. The P/E ratio based on current earnings is 23.72 and the P/E ratio based on expected earnings is 17.48. The expected growth rate in Apples earnings must be:

1. A) -26%.
2. B) 36%.
3. C) 7.6%.
4. D) 5.5%.

Answer: B

Diff: 3

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

11) The P/E ratio is the market price of a share of stock divided by book equity per share.

Answer: FALSE

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

12) The higher a firm's P/E ratio, the more optimistic investors' feel about the firm's growth prospects.

Answer: TRUE

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

13) P/E ratios found in published sources or on the internet are always computed by dividing the next period's expected earnings into the current price of the stock.

Answer: FALSE

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

14) The higher the investor's required rate of return, the higher the P/E ratio will be.

Answer: FALSE

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

15) Walmart's current earnings per share of $4.39 are expected to grow at a rate of 12% per year for the next few years. Using a P/E ratio fo 12.5, what is a reasonable value for a share of Walmart Stock.

Answer: A reasonable value for Walmart would be $4.39(1.12)(12.5)=$61.46 per share.

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

16) RAH Inc. is not publicly traded, but the P/E ratios of it's 4 closest competitors are 15, 15.3, 15.7, and 16.5. RAH's current earnings per share are $1.50. They are expected to grow at 6% for the next few years. What is a reasonable price for a share of RAH stock?

Answer: An appropriate P/E ratio would be an average of the 4 competitors (15+15.3+15.7+16.5)/4=15.625. A reasonable price would be $1.50(1.06)(15.625)=$24.84.

Diff: 2

Topic: 10.2 The Comparables Approach to Valuing Common Stock

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

10.3 Preferred Stock

1) UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%, how much will you be willing to pay for one share?

38. A) $38.46
39. B) $26.26
40. C) $65.46
41. D) $46.38

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

2) Green Corp.'s preferred stock is selling for $20.83. If the company pays $2.50 annual dividends, what is the expected rate of return on its stock?

8. A) 8.33%
9. B) 12.00%
10. C) 2.50%
11. D) 20.00%

Answer: B

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

3) Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on this stock. What is the value of the preferred stock today? Round to the nearest $1.

1. A) $100
2. B) $85
3. C) $75
4. D) $16

Answer: C

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

4) Which of the following statements is true?

1. A) Preferred stockholders are entitled to dividends before common stockholders can receive dividends.
2. B) Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay back the investment.
3. C) The market value of preferred stock, like bonds, will usually fluctuate in value primarily as the result of market rates of interest.
4. D) All of the above.

Answer: D

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

5) Which of the following statements concerning preferred stock is correct?

1. A) Preferred stock generally is more costly to the firm than common stock.
2. B) Most issues of preferred stock have a cumulative feature.
3. C) Preferred dividend payments are tax-deductible.
4. D) Preferred stock is a riskier form of capital to the firm than bonds.

Answer: B

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: cumulative preferred

Principles: Principle 3: Cash Flows Are the Source of Value

6) World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with an annual dividend of $5 per share. The stock will have a par value of $30. If investors' required rate of return on this investment is currently 20%, what should the preferred stock's market value be?

1. A) $10
2. B) $15
3. C) $20
4. D) $25

Answer: D

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

7) Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock pays a dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the preferred stockholder's expected rate of return? Round to the nearest 0.01%.

6. A) 6.30%
7. B) 7.88%
8. C) 10.25%
9. D) 5.02%

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

8) Murky Pharmaceuticals has issued preferred stock with a par value of $100 and a 5% dividend. The investors' required yield is 10%. What is the value of a share of Murky preferred?

1. A) $100
2. B) $75
3. C) $50
4. D) $25

Answer: C

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

9) Edison Power of light has an outstanding issue of cumulative preferred stock with an annual fixed dividend of $2.00 per share. It has not paid the preferred dividend for the last 3 years, but intends to pay a dividend on the common stock in the coming year. Before Edison can pay a dividend on the common stock

1. A) preferred shareholders may cast all their votes for a single director.
2. B) preferred shareholders must receive dividends totaling $8.00 per share.
3. C) preferred shareholders must receive $2.00 per share.
4. D) will not necessarily receive any dividend.

Answer: B

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: cumulative preferred

Principles: Principle 3: Cash Flows Are the Source of Value

10) Which of the following provisions is unique to preferred stockholders and usually NOT available to common stockholders?

1. A) Cumulative dividends feature
2. B) Voting rights
3. C) Fixed dividend
4. D) Both A and C

Answer: D

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: cumulative preferred

Principles: Principle 3: Cash Flows Are the Source of Value

11) McMillen House of Books recently paid a $3 dividend on its preferred stock. Investors require a 6% return on the stock. The stock is currently selling for $45. Is the stock a good buy?

5. A) Yes, as it is undervalued $5.
6. B) Yes, as it is undervalued $10.
7. C) No, as it is overvalued $5.
8. D) No, as it is overvalued $10.

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

12) Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value. Par value of TSP preferred stock is $100 per share. If investors' required rate of return on this stock is 15%, what is the value of per share?

37. A) $37.50
38. B) $15.00
39. C) $16.67
40. D) $6.00

Answer: C

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

13) Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the stock is currently selling for $21.25 per share, what is the expected rate of return on this stock.

36. A) 36.13%
37. B) 12.5%
38. C) 8.0%
39. D) 13.6%

Answer: C

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

14) Horizon Communications stock pays a fixed annual dividend of of $3.00. Because of lower inflation, the market's required yield on this preferred stock has gone from 12% to 10%. As a result:

1. A) Horizon's dividend decreased by 6 cents.
2. B) The value of Horizon's preferred increased by $3.00.
3. C) The value of Horizon's preferred decreased by $5.00.
4. D) The value of Horizon's preferred increased by $5.00.

Answer: D

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 1: Money Has a Time Value

15) Style Corp. preferred stock pays $3.15. What is the value of the stock if your required rate of return is 8.5% (round your answer to the nearest $1, and assume no transaction costs)?

1. A) $33
2. B) $23
3. C) $27
4. D) $37

Answer: D

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

16) Preferred stock is similar to a bond in the following way.

1. A) Preferred stock always contains a maturity date.
2. B) Both investments provide a fixed income.
3. C) Both contain a growth factor similar to common stock.
4. D) None of the above.

Answer: B

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

17) Solitron Manufacturing Company preferred stock is selling for $14. If it has a yearly dividend of $1, what is your expected rate of return if you purchase the stock at its market price (round your answer to the nearest .1%, and assume no transaction costs)?

25. A) 25.0%
26. B) 14.2%
27. C) 7.1%
28. D) 9.3%

Answer: C

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

18) An decrease in the ________ will increase the value of preferred stock.

1. A) expected rate of return
2. B) life of the investment
3. C) dividend paid
4. D) both A and C

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

19) Texon's preferred stock sells for $85 and pays $11 each year in dividends. What is the expected rate of return?

Answer: Required rate of return = = 0.129

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

20) What is the value of a preferred stock that pays a $2.10 dividend to an investor with a required rate of return of 11% (round your answer to the nearest $1)?

1. A) $19
2. B) $23
3. C) $17
4. D) $21

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

21) Which of the following formulas is appropriate to find the value of preferred stock with a fixed dividend?

1. A) Value of preferred stock = Annual Preferred Stock Dividend (1+ growth rate)/Market's Required Yield on Preferred Stock
2. B) Value of preferred stock = Annual Preferred Stock Dividend (1+ growth rate)/Market's Required Yield on Preferred Stock - growth rate
3. C) Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on Preferred Stock
4. D) Value of preferred stock = Annual Preferred Stock Dividend/Investor's Required Yield on Preferred Stock

Answer: C

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

22) An issue of preferred stock currently sells for $52.50 per share and pays a constant annual expected dividend of $2.25 per share. The expected return on this security is:

4. A) 4.29%.
5. B) 0.04%.
6. C) 8.33%.
7. D) 13.33%.

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

23) Expected cash flow for a preferred stock primarily consists of:

1. A) dividend payments .
2. B) changes in the price of the stock.
3. C) interest payments.
4. D) both A and B.

Answer: A

Diff: 2

Topic: 10.3 Preferred Stock

Keywords: market required yield

Principles: Principle 3: Cash Flows Are the Source of Value

24) Preferred stock is similar to common stock in that:

1. A) it has no fixed maturity date.
2. B) the nonpayment of dividends can bring on bankruptcy.
3. C) dividends are limited in amount.
4. D) all of the above.

Answer: A

Diff: 2

A bond paying interest of $120 per year forever is an example of a perpetuity.
TRUE/FALSE

TRUE

The formula for calculating the present value of a perpetuity is P = A/(1 + i)

TRUE/FALSE

FALSE

A perpetuity is an investment that continues forever but pays a different dollar amount each year.

TRUE/FALSE

FALSE

The present value of a $100 perpetuity discounted at 5% is $1200

TRUE/FALSE

FALSE

All else constant, an individual would be indifferent between receiving $2,000 today or receiving a $200 perpetuity when the discount rate is 10% annually

TRUE/FALSE

TRUE

What is the value on 1/1/05 of the following cash flows? Use a 10% discount rate, and round your answer to the nearest $10.

Date Cash Received Amount of Cash
1/1/07 $100
1/1/08 $200
1/1/09 $300
1/1/10 $400
1/1/11 $500
A) $490
B) $460
C) $970
D) $450

1. C) $970

Consider the following cash flows:

Date Cash Received Amount of Cash
1/1/07 $100
1/1/08 $100
1/1/09 $500
1/1/10 $100

What is the value on 1/1/05 of the above cash flows? Use an 8% discount rate, and round your answer to the nearest $10.
A) $600
B) $620
C) $630
D) $650

1. A) $600

If you put $200 in a savings account at the beginning of each year for 10 years and then allow the account to compound for an additional 10 years, how much will be in the account at the end of the 20th year? Assume that the account earns 10%, and round to the nearest $10.
A) $8,300
B) $9,100
C) $8,900
D) $9,700

1. B) $9,100

An investment is expected to yield $300 in three years, $500 in five years, and $300 in seven years. What is the present value of this investment if our opportunity rate is 5%?
A) $735
B) $865
C) $885
D) $900

1. B) $865

Jay Coleman just graduated. He plans to work for five years and then leave for the Australian "Outback" country. He figures that he can save $3,500 a year for the first three years and $5,000 a year for the next two years. These savings will start one year from now. In addition, his family gave him a $2,500 graduation gift. If he puts the gift, and the future savings when they start, into an account that pays 7.75% compounded annually, what will his financial "stake" be when he leaves for Australia five years from now? Round off to the nearest $1.
A) $36,082
B) $24,725
C) $30,003
D) $27,178

1. D) $27,178

You are thinking of buying a miniature golf course. It is expected to generate cash flows of $40,000 per year in years one through four and $50,000 per year in years five through eight. If the appropriate discount rate is 10%, what is the present value of these cash flows?
A) $285,288
B) $167,943
C) $235,048
D) $828,230

1. C) $235,048

You have been depositing money at the end of each year into an account drawing 8% interest. What is the balance in the account at the end of year four if you deposited the following amounts?

Year End of Year Deposit
1 $350
2 $500
3 $725
4 $400
A) $1,622
B) $2,207
C) $2,384
D) $2,687

1. B) $2,207

You want to travel to Europe to visit relatives when you graduate from college three years from now. The trip is expected to cost a total of $10,000. Your parents have deposited $5,000 for you in a CD paying 6% interest annually, maturing three years from now. Aunt Hilda has agreed to finance the balance. If you are going to put Aunt Hilda's gift in an investment earning 10% annually over the next three years, how much must she deposit now so you can visit your relatives in three years?
A) $3,757
B) $3,039
C) $3,801
D) $3,345

1. B) $3,039

What is the present value of the following uneven stream of cash flows? Assume a 6% discount rate and end-of-period payments. Round to the nearest whole dollar.
Year Cash Flow
1 $3,000
2 $4,000
3 $5,000
A) $10,588
B) $11,461
C) $12,688
D) $13,591

1. A) $10,588

As a part of your savings plan at work, you have been depositing $250 per quarter in a savings account earning 8% interest compounded quarterly for the last 10 years. You will retire in 15 years and want to increase your contribution each year from $1,000 to $2,000 per year, by increasing your contribution every four months from $250 to $500. Additionally, you have just inherited $10,000, which you plan to invest now to earn interest at 12% compounded annually for the next 15 years. How much money will you have in savings when you retire 15 years from now?
A) $126,862
B) $73,012
C) $161,307
D) $194,415

1. C) $161,307

Ronald Slump purchased a real estate investment with the following end-of-year cash flows:

Year EOY Cash Flow
1 $200
2 $-350
3 $-430
4 $950

What is the present value of these cash flows if the appropriate discount rate is 20%?
A) $178
B) $160
C) $133
D) $767

1. C) $133

You have just won a magazine sweepstakes and have a choice of three alternatives. You can get $100,000 now, or $10,000 per year in perpetuity, or $50,000 now and $150,000 at the end of 10 years. If the appropriate discount rate is 12%, which option should you choose?
A) $100,000 now
B) $10,000 perpetuity
C) $50,000 now and $150,000 in 10 years

1. A) $100,000 now

Your parents are planning to retire in Phoenix, AZ in 20 years. Currently, the typical house that pleases your parents costs $200,000, but they expect inflation to increase the price of the house at a rate of 4% over the next 20 years. In order to buy a house upon retirement, what must they save each year in equal annual end-of-year deposits if they can earn 10% annually?
A) $21,910.00
B) $7,650.94
C) $10,000.00
D) $14,715.52

650. B) $7,650.94

You intend to purchase your dream PC upon graduation in two years. It will have a cost of $2,975, including all attachments and sales tax. You just received a $3,000 pre-graduation gift from your rich uncle that you intend to deposit in a money market account that pays 6% interest, compounded monthly. How much of your pre-graduation gift will you need to deposit in order to have $2,975 available for the purchase of the PC upon graduation?
A) $1,275
B) $2,588
C) $2,975
D) $1,567
E) $2,639

1. E) $2,639

Assume that two investments have a three-year life and generate the cash flows shown below. Which of the two would you prefer?

Year Investment A Investment B
1 $5,000 $8,000
2 $5,000 $5,000
3 $5,000 $2,000
A) Investment A, since it has the most even cash flows
B) Investment B, since it gives you the largest cash flows in earlier years
C) Neither, since they both have equal lives
D) Both investments are equally attractive
E) None of the above

1. B) Investment B, since it gives you the largest cash flows in earlier years

You have just purchased an investment that generates the cash flows that are shown below. You are able to invest your money at 5.75%, compounded annually. How much is this investment worth today?

Year Amount
0 $0
1 $1,250
2 $1,585
3 $1,750
4 $2,225
5 $3,450
A) $7,758
B) $4,521
C) $10,260
D) $8,467
E) $6,583

1. D) $8,467

To evaluate and compare investment proposals, we must adjust all cash flows to a common date.

TRUE/FALSE

TRUE

Chapter 10 Stock Valuation

10.1 Common Stock

1) The XYZ Company, whose common stock is currently selling for $40 per share, is expected to pay a $2.00 dividend in the coming year. If investors believe that the expected rate of return on XYZ is 14%, what growth rate in dividends must be expected?

1. A) 5%
2. B) 14%
3. C) 9%
4. D) 6%

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

2) 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?

1. A) (D1+ g)/Vc
2. B) D1/Vc + g
3. C) D1/g
4. D) D1/Vc

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

3) Green Company's common stock is currently selling at $24.00 per share. The company recently paid dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what is the stock's expected rate of return?

4. A) 4.08%
5. B) 8.00%
6. C) 12.00%
7. D) 8.80%

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

4) Common stockholders are essentially

1. A) creditors of the firm.
2. B) managers of the firm.
3. C) owners of the firm.
4. D) all of the above.

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

5) Butler, Inc.'s return on equity is 17% and management retains 75% of earnings for investment purposes. Based on this information, what will be the firm's growth rate?

4. A) 4.25%
5. B) 22.67%
6. C) 44.12%
7. D) 12.75%

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

6) If a company has a return on equity of 25% and wants a growth rate of 10%, how much of ROE should be retained?

1. A) 40%
2. B) 50%
3. C) 60%
4. D) 70%

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

7) ________ gives minority shareholders more power to elect board of directors.

1. A) Preemptive right
2. B) Majority voting
3. C) Proxy fights
4. D) Cumulative voting

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

8) You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected dividends.

4. A) $4.91
5. B) $5.40
6. C) $9.80
7. D) $6.80

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

9) You are evaluating the purchase of Charbridge, Inc. common stock which currently pays no dividend and is not expected to do so for many years. Because of rapidly growing sales and profits, you believe the stock will be worth $51.50 in 3 years. If your required rate of return is 16%, what is the stock worth today?

59. A) $59.74
60. B) $51.25
61. C) $32.99
62. D) $0.00 because stocks that do not pay dividends have no value.

Answer: C

Diff: 3

AACSB: 3. Analytic thinking

Question Status: New question

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

10) CEOs naming friends to the board of directors and paying them more than the norm is an example of the

1. A) agency problem.
2. B) preemptive right.
3. C) majority voting feature.
4. D) proxy fights.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

11) Little Feet Shoe Co. just paid a dividend of $1.65 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 of per share of LFS stock.

20. A) $20.63
21. B) $21.24
22. C) $15.00
23. D) $55.00

Answer: B

Diff: 1

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

12) Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year. You expect the stock to grow at 5% per year. If the appropriate rate of return on this stock is 12%, how much are you willing to pay for the stock today?

13. A) $13.00
14. B) $15.00
15. C) $17.00
16. D) $19.00

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

13) Marble Corporation's ROE is 17%. Their dividend payout ratio is 20%. The last dividend, just paid, was $2.58. If dividends are expected to grow by the company's sustainable growth rate indefinitely, what is the current value of Marble common stock if its required return is 18%?

14. A) $14.33
15. B) $18.27
16. C) $47.67
17. D) $66.61

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

14) Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely. Compute the required rate of return on FBC stock.

1. A) 10%
2. B) 33%
3. C) 7%
4. D) 4.3%

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

15) You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01.

36. A) $36.65
37. B) $91.23
38. C) $51.55
39. D) $74.82

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

16) A stock currently sells for $63 per share, and the required return on the stock is 10%. Assuming a growth rate of 5%, calculate the stock's last dividend paid.

1. A) $1
2. B) $3
3. C) $5
4. D) $7

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

17) A decrease in the ________ will cause an increase in common stock value.

1. A) growth rate
2. B) required rate of return
3. C) last paid dividend
4. D) both B and C

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

18) Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as dividends, its expected growth rate will be

4. A) new 4.80%.
5. B) 7.20%.
6. C) 12%.
7. D) 6%.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

19) An investor is contemplating the purchase of common stock at the beginning of this year and to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end price for the stock of $40. If this investor's required rate of return is 10%, then the value of the stock to this investor is

36. A) $36.36.
37. B) $38.18.
38. C) $33.06.
39. D) $34.88.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

20) A firm just paid $2.00 on its common stock and expects to continue paying dividends, which are expected to grow 5% each year, from now to infinity. If the required rate of return for this stock is 9%, then the value of the stock is

50. A) $50.00.
51. B) $40.00.
52. C) $54.50.
53. D) $52.50.

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

21) An issue of common stock currently sells for $40.00 per share, has an expected dividend to be paid at the end of the year of $2.00 per share, and has an expected growth rate to infinity of 5% per year. The expected rate of return on this security is

1. A) 5%.
2. B) 10.25%.
3. C) 13.11%.
4. D) 10%.

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

22) Common shareholders have a claim on the company's assets

1. A) at any time, equal to the value of their shares.
2. B) only after the claims of debtholders and preferred shareholders have been satisfied.
3. C) after the claims of the preferred shareholders have been satisfied, but before the debt holders.
4. D) never. Common shareholders have no claim on the company's assets.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: New question

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

23) KDP's most recent dividend was $2.00 per share and is selling today in the market for $70. The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the market return is 10% on investments with comparable risk, should you purchase the stock?

1. A) No, because the stock is overpriced $1.33.
2. B) No, because the stock is overpriced $3.33.
3. C) Yes, because the stock is underpriced $1.33.
4. D) Yes, because the stock is underpriced $3.33.

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

24) An issue of common stock currently sells for $50.00 per share, has an expected dividend to be paid at the end of the year of $2.50 per share, and has an expected growth rate to infinity of 5% per year. If investors' required rate of return for this particular security is 12% per year, then this security is

1. A) overvalued and offering an expected return higher than the required return.
2. B) undervalued and offering an expected return higher than the required return.
3. C) overvalued and offering an expected return lower than the required return.
4. D) undervalued and offering an expected return lower than the required return.

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

25) You are considering the purchase of Miller Manufacturing, Inc.'s common stock. The stock is selling for $21.00 per share. The next dividend is expected to be $2.10, and you expect the dividend to keep growing at a constant rate. If the stock is returning 15%, calculate the growth rate of dividends.

1. A) 3%
2. B) 5%
3. C) 8%
4. D) 10%

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

26) ABC, Inc. just paid a dividend of $2. ABC expects dividends to grow at 10%. The return on stocks like ABC, Inc. is typically around 12%. What is the most you would pay for a share of ABC stock?

1. A) $100
2. B) $110
3. C) $120
4. D) $130

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

27) Marjen, Inc. just paid a dividend of $5. Marjen stock currently sells for $73.57. The return on stocks like Marjen, Inc. is around 10%. What is the implied growth rate of dividends.

1. A) 1%
2. B) 3%
3. C) 5%
4. D) 7%

Answer: B

Diff: 3

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

28) Which investor incurs the greatest risk?

1. A) Mortgage bondholder
2. B) Preferred stockholder
3. C) Common stockholder
4. D) Debenture bondholder

Answer: C

Diff: 1

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

29) What allows common stockholders the right to cast a number of votes equal to the number of directors being elected?

1. A) The majority voting provision
2. B) The casting feature
3. C) The cumulative voting provision
4. D) The proxy method

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

30) The shareholder can cast all votes for a single candidate or split them among various candidates through

1. A) proxy fights.
2. B) cumulative voting.
3. C) call provisions.
4. D) majority voting.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

31) You are considering the purchase of common stock that just paid a dividend of $6.50 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 18%. How much should you expect to pay for this stock?

1. A) $86
2. B) $94
3. C) $108
4. D) $121
5. E) $242

Answer: D

Diff: 1

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

32) You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share. The stock is selling for $115 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the expected dividends be worth today?

12. A) $12.60
13. B) $9.21
14. C) $17.12
15. D) $15.55
16. E) $11.46

Answer: E

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

33) A share of common stock just paid a dividend of $3.25 per share. The expected long-run growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the price of the stock be?

57. A) $57.51
58. B) $62.25
59. C) $71.86
60. D) $63.92

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

34) Common stockholders expect greater returns than bondholders because

1. A) they have no legal right to receive dividends.
2. B) they bear greater risk.
3. C) in the event of liquidation, they are only entitled to receive any cash that is left after all creditors are paid.
4. D) all of the above.

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

35) WSU Inc. is a young company that does not yet pay a dividend. You believe that the company will begin to pay dividends 5 years from now, and that the company will then be worth $50 per share. If your required rate of return on this risky stock is 20%, what is the stock worth today?

1. A) $40
2. B) $10
3. C) $20.09
4. D) $0.00

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

36) Common stockholders are essentially creditors of the firm.

Answer: FALSE

Diff: 1

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

37) Common stock represents a claim on residual income.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

38) The growth rate of future earnings is determined by return on equity and the profit-retention rate.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

39) The stockholder's expected rate of return consists of a dividend yield and interest.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

40) When bankruptcy occurs, the claims of the common shareholders may go unsatisfied.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

41) Cumulative voting gives each share of stock a number of votes equal to the number of directors being elected to the board.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

42) The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

43) Stock valuation is more precise than bond valuation as stock cash flows are more certain.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

44) The stock valuation model D1/(Rc - g) requires Rc > G.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

45) Is the following common stock priced correctly? If no, what is the correct price?

Price = $26.25

Required rate of return = 13%

Dividend year 0 = $2.00

Dividend year 1 = $2.10

Answer:

Growth rate = = 5%

Vcs = 2.10 /(.13 - .05)= $26.25

The stock is priced correctly.

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

46) The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of $3.68 is expected to be distributed, 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?

Answer:

R = (D/V) + g

R = ($3.68/$26.75) + .055

R = 19.26%

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

47) 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?

Answer:

Rc = 2.40/48 + (2.40 - 2.00)/2.00

= .05 + .20

= 25%

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

48) Draper Company's common stock paid a dividend last year of $3.70. You believe that the long-term growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how much are you willing to pay for the stock?

Answer: P0 = = = $66.60

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

49) Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.

Answer: Kcs = + 5% = 10% + 5% = 15%

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

50) You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX Company stock?

Answer:

Vc = $2.00 PVIF12%,1 + $19.75 PVIF12%,2

= ($2.00)(.893) + ($19.75)(.797)

= $17.53

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

51) You can purchase one share of Sumter Company common stock for $80 today. You expect the price of the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?

Answer:

$80.00 = +

$80.00 (1 + R) = $88.00

(1 + R) = = $1.10

R = .10

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.1 Identify the basic characteristics and features of common stock and use the discounted cash flow model to value common shares.

Keywords: common stock

Principles: Principle 3: Cash Flows Are the Source of Value

FIN 100 Principles of Finance Part 1

FIN 100 Principles of Finance Part 2

FIN 100 Principles of Finance Part 3

FIN 100 Principles of Finance Part 4