Deck 10: Valuation and Rates of Return

Question 1

A 4-year bond pays 4% annual interest (paid semi-annually). It currently sells for $872.25. What is the bond's yield to maturity?

A) 4.00%
B) 4.59%
C) 6.06%
D) 7.78%

Answer 1

D

Question 2

Valuation of financial assets requires knowledge of:

A) future cash flows.
B) appropriate discount rate.
C) past asset performance.
D) future cash flows and appropriate discount rate.

Answer 2

D

Question 3

Stock valuation models are dependent upon:

A) expected dividends, future dividend growth, and an appropriate discount rate.
B) past dividends, flotation costs, and bond yields.
C) historical dividends, historical growth, and an appropriate discount rate.
D) cost of capital.

Answer 3

A

Question 4

The market allocates capital to companies based on:

A) risk.
B) effectiveness.
C) previous returns.
D) need.

Question 5

An issue of common stock is expected to pay a dividend of $4.80 at the end of the year. Its growth rate is equal to 8%. If the required rate of return is 13%, what is its current price?

A) $103.68
B) $36.92
C) $96.00
D) $48.00

Question 6

An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm's common stock is 14%. What is the preferred stock price if the required rate of return is 11%?

A) $45.45
B) $41.67
C) $35.71
D) $31.45

Question 7

An issue of common stock is selling for $57.20. The year-end dividend is expected to be $2.32 assuming a constant growth rate of 6%. What is the required rate of return?

A) 10.3%
B) 10.1%
C) 4.1%
D) 6.0%

Question 8

The value of a common stock is based on its:

A) past performance.
B) divided yield.
C) current earnings.
D) future benefits to the holder.

Question 9

The cost of common stock is usually greater than the simple dividend yield because:

A) investors perceive risk in common stock.
B) investors expect both a current dividend and future growth.
C) dividends are not tax-deductible.
D) the company must make profits before it can pay dividends.

Question 10

Which is a characteristic of the cost of preferred stock?

A) Preferred stock dividends are fixed, they are tax deductible.
B) Preferred stock has no maturity, the cost analysis is similar to that of debt.
C) Preferred stock is valued as a perpetuity.
D) The price earnings ratio stays the same.

Question 11

The relationship between a bond's price and the yield to maturity:

A) changes at a constant level for each percentage change of yield to maturity.
B) is an inverse relationship.
C) is a linear relationship.
D) changes at a constant level for each percentage change of yield to maturity and is an inverse relationship.

Question 12

The cost of capital for common stock is K_e = (D₁/P_o) + g. What are the assumptions of the model?

A) Growth (g) is constant to infinity
B) The price earnings ratio stays the same
C) The firm must pay a dividend to use this model
D) Dividends are tax deductible

Question 13

If expected dividends grow at 8% and the appropriate discount rate is 12%, what is the value of a share with an expected dividend of $2.33?

A) $62.88
B) $19.41
C) $29.12
D) $58.25

Question 14

Which of the following does not influence the yield to maturity for a security?

A) Required real rate of return
B) Risk free rate
C) Business risk
D) Yields of similar securities

Question 15

A 10-year bond pays 11% interest on a $1,000 face value annually. If it currently sells for $1,195, what is its approximate yield to maturity?

A) 8.33%
B) 12.95%
C) 11.00%
D) 8.08%

Question 16

An issue of common stock has just paid a dividend of $3.75. Its growth rate is 8%. What is its price if the market's rate of return is 16%?

A) $25.01
B) $46.88
C) $50.63
D) $54.38

Question 17

The dividend valuation model stresses the:

A) importance of earnings per share.
B) importance of dividends and legal rules for maximum payment.
C) relationship of dividends to market prices.
D) relationship of dividends to earnings per share.

Question 18

A 20-year bond pays 12% on a face value of $1,000. If similar bonds are currently yielding 9%, what is the market value of the bond?

A) Over $1,000
B) Under $1,000
C) Over $1,200
D) Not enough information given to tell

Question 19

A 14-year zero-coupon bond was issued with a $1,000 par value and a yield to maturity of 9%. If similar bonds are currently yielding 12%, what is the approximate market value of the bond?

A) $205
B) $299
C) $801
D) $1,000

Question 20

A 10-year bond pays 8% annual interest (paid semi-annually). If similar bonds are currently yielding 6% annually, what is the market value of the bond?

A) $1,000.00
B) $1,147.20
C) $1,148.77
D) $1,080.00

Question 21

Which of the following is not a component of a bond's required rate of return?

A) Risk premium
B) Real rate of return
C) Inflation premium
D) Maturity payment

Question 22

The risk premium is likely to be highest for:

A) government bonds.
B) corporate bonds.
C) gold mining expedition.
D) blue chip stock.

Question 23

A "supernormal growth" firm is one in which:

A) sales grow at a very rapid rate.
B) the firm's earnings grow at a high rate for many years into the future.
C) the firm's dividends grow alternatively at high, then low, rates.
D) the firm's dividends grow at a high rate for several periods, then at a lower rate afterward.

Question 24

An increase in the riskiness of a particular security would NOT affect:

A) the risk premium for that security.
B) the premium for expected inflation.
C) the total required return for the security.
D) investors' willingness to buy the security.

Question 25

To value the common stock of a supernormal growth firm, an analyst could forecast the length of the supernormal growth period and the dividends paid, and then find the:

A) total of the dividends paid.
B) total of the dividends paid and multiply by the length of the growth period.
C) present value of the supernormal growth period's dividends.
D) present value of the supernormal growth period's dividends and add the present value of the stock price at the end of the growth period.

Question 26

In a general sense, the value of any asset is the:

A) value of the dividends received from the asset.
B) present value of the expected cash flows received from the asset.
C) value of past dividends and price increases for the asset.
D) future value of the expected cash flows to be received from the asset.

Question 27

A 15-year bond pays 11% on a face value of $1,000. If similar bonds are currently yielding 8%, what is the market value of the bond?

A) Over $1,000
B) Under $1,000
C) Over $1,200
D) Under $800

Question 28

If the inflation premium for a bond goes up, the price of the bond:

A) is unaffected.
B) goes down.
C) goes up.
D) need more information.

Question 29

If a company's stock price (P_o) goes up, and nothing else changes, K_e (the required rate of return) should:

A) go up.
B) go down.
C) remain unchanged.
D) need more information.

Question 30

A higher interest rate (discount rate) would:

A) increase the price of corporate bonds.
B) reduce the price of preferred stock.
C) increase the price of common stock.
D) reduce the cost of dividends.

Question 31

The return measure that an investor demands for giving up current use of funds, without adjusting for purchasing power changes, is the:

A) risk premium.
B) inflation premium.
C) real rate of return.
D) discount rate.

Question 32

Which of the following financial assets is likely to have the highest required rate of return based on risk?

A) Corporate bond
B) Treasury bill
C) Preferred share
D) Common share

Question 33

If in determining the yield to maturity on a bond at a given interest rate, you get a value below the current market price, in the next calculation you should use:

A) a higher interest rate.
B) a lower interest rate.
C) a longer maturity.
D) a higher coupon payment.

Question 34

A bond which has a yield to maturity greater than its coupon interest rate will sell for a price:

A) below par.
B) at par.
C) above par.
D) that is equal to the face value of the bond plus the value of all interest payments.

Question 35

Preferred stock has all, except which of the following characteristics?

A) No stated maturity
B) A fixed dividend payment that carries a higher precedence than common stock dividends
C) The same binding contractual obligation as debt
D) Preferred lacks the ownership privilege of common stock

Question 36

A bond pays 9% yearly interest in semi-annual payments for 6 years. The current yield on similar bonds is 12%. To determine the market value of this bond, you must:

A) find the interest factors (IFs) for 12 periods at 12%.
B) find the interest factors (IFs) for 6 periods at 9%.
C) find the interest factors (IFs) for 6 periods at 6%.
D) find the interest factors (IFs) for 12 periods at 6%.

Question 37

A common stock which pays a constant dividend can be valued as if it were:

A) a corporate bond.
B) stock paying a growing dividend.
C) a preferred stock.
D) a discount bond.

Question 38

The price of preferred stock may react strongly to a change in k_p because:

A) preferred stock may be cumulative.
B) preferred stock dividends have to be paid before common stock dividends.
C) there is no maturity date.
D) preferred stock dividends pass tax free between corporations.

Question 39

The longer the time to maturity:

A) the greater the price increase from a given increase in yield.
B) the less the price increase from a given increase in yield.
C) the greater the price increase from a given decrease in yield.
D) the less the price increase from a given decrease in yield.

Question 40

The dividend on preferred shares is most similar to:

A) common shares with no growth in dividends.
B) common shares with constant growth in dividends.
C) common shares with variable growth in dividends.
D) a term deposit.

Question 41

The longer the supernormal growth period for a firm's lasts,:

A) the higher the value of its common stock.
B) the lower the value of its common stock.
C) the higher the value of its preferred stock.
D) the lower the required rate of return used in finding the price of its common stock.

Question 42

The value of a supernormal growth firm's common stock is the present value of the:

A) first year's dividend after the supernormal growth period.
B) expected stock price at the start of the supernormal growth period.
C) first year's dividends multiplied by (1 - the supernormal growth rate), divided by the required rate of return.
D) expected stock price at the end of the supernormal growth period.

Question 43

A 10-year bond pays 12% interest on a $1,000 face value annually. If it currently sells for $1,100, what is its approximate yield to maturity?

A) 10.35%
B) 10.91%
C) 11.00%
D) 12.00%

Question 44

A 10-year bond pays 8% annual interest (paid semi-annually). If similar bonds are currently yielding 5% annually, what is the market value of the bond?

A) $1,000.00
B) $1,857.40
C) $1,233.84
D) $1,080.00

Question 45

A 15-year zero-coupon bond was issued with a $1,000 par value and a yield to maturity of 8%. If similar bonds are currently yielding 10%, what is the market value of the bond?

A) $239.39
B) $315.24
C) $800.00
D) $1,000.00

Question 46

The valuation of a financial asset is based on the concept of determining the present value of future cash flows.

Question 47

An issue of common stock is expected to pay a dividend of $4.00 at the end of the year. Its growth rate is equal to 8%. If the required rate of return is 15%, what is its current price?

A) $103.68
B) $50.00
C) $26.67
D) $57.14

Question 48

An issue of common stock has just paid a dividend of $4.50. The dividend growth rate is 10%. What is its price if the market's rate of return is 16%?

A) $82.50
B) $45.00
C) $28.13
D) $75.00

Question 49

If expected dividends grow at 8% and the appropriate discount rate is 11%, what is the value of a share with an expected dividend of $2.50?

A) $22.73
B) $31.25
C) $13.16
D) $83.33

Question 50

The market determined required rate of return is also called the discount rate.

Question 51

Gamble and Johnson's (GJ) common shares are selling for $52.50. They are expected to pay a dividend of $2.25 next year and dividends should grow at a rate of 7% annually. What is your required rate of return on an investment in GJ common shares?

A) 11.30%
B) 19.25%
C) 12.00%
D) 15.75%

Question 52

A lower interest rate (discount rate) would:

A) reduce the price of corporate bonds.
B) reduce the price of preferred stock.
C) increase the discount rate.
D) increase the price of common stock.

Question 53

You want to buy 100 shares of Aquarific, Ltd. (AL). Your required rate of return is 12% and you expect AL's sales and earnings to grow by 5% annually beginning 4 years from today. Over the next 2 years AL is expected to break even. However, in year 3 AL is expected to earn $1.75 a share. What is the maximum price that you would pay for 100 shares of AL?

A) $1,780
B) $1,589
C) $2,500
D) $1,869

Question 54

The prices of financial assets are based on the expected value of future cash flows, discount rate, and past dividends.

Question 55

The method used for finding the value of a supernormal growth firm's common stock at the end of the supernormal growth period is similar to that used to find the value of:

A) a firm's preferred stock.
B) a firm's common stock, with a constant growth rate for its dividends.
C) a firm's interest-paying bonds.
D) a firm's percentage increase in sales growth.

Question 56

The discount rate depends on the market's perceived level of risk associated with an individual security.

Question 57

A bond with a coupon rate of 6%, paid quarterly, and 5 years to maturity is being offered in the market. If bonds with similar risks are currently being paid 3%, what is the price you would pay for this bond?

A) $1,972
B) $1,139
C) $1,000
D) $862

Question 58

A bond which has a yield to maturity less than its coupon interest rate will sell for a price:

A) below par.
B) at par.
C) above par.
D) that is equal to the face value of the bond plus the value of all interest payments.

Question 59

An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm's common stock is 12%. What is the preferred stock price if the required rate of return is 10%?

A) $50.00
B) $41.67
C) $22.73
D) $5.00

Question 60

An issue of common stock is selling for $64.50. The year-end dividend is expected to be $3.30 assuming a constant growth rate of 7%. What is the required rate of return?

A) 12.1%
B) 10.1%
C) 4.1%
D) 5.1%

Question 61

As time to maturity increases, bond price sensitivity decreases.

Question 62

The yield to maturity is always equal to the interest payment of a bond.

Question 63

A rise in yield to maturity would be coupled with an increase in the price of a bond.

Question 64

The risk premium is equal to the required yield to maturity minus the risk-free rate (the real rate of return and the inflation premium).

Question 65

The required rate of return is payment given to the investor for forgoing present consumption.

Question 66

The total required real rate of return is equal to the nominal rate of return plus the inflation premium.

Question 67

By using different discount rates, the market allocates capital to companies based on their risk, efficiency, and expected returns.

Question 68

The variable growth model is useful for firms in emerging industries.

Question 69

The longer the maturity of a bond, the greater the impact on price to changes in market interest rates.

Question 70

The inflation premium is based on past and current inflation levels.

Question 71

Historically the real rate of return has been 2 to 3%.

Question 72

Preferred stock is compensated for not having ownership privileges with a fixed dividend stream supported by a binding contractual obligation (of interest on debt).

Question 73

The price of a bond is equal to the present value of all future interest payments added to the present value of the principal.

Question 74

The appropriate discount rate for bonds is called the yield to maturity.

Question 75

A 20-year bond pays 12% annual interest in semi-annual payments. The current market yield to maturity is 10%. The appropriate interest factors should use 5% for 40 periods (by tables or calculator).

Question 76

The risk premium is primarily concerned with business risk, financial risk, and economic risk.

Question 77

The price of preferred stock is determined by dividing the fixed dividend payment by the required rate of return.

Question 78

The risk-free rate of return is equal to the inflation premium plus the real rate of return.

Question 79

Most bonds promise both a periodic return and a lump-sum payment.

Question 80

In estimating the market value of a bond, the coupon rate should be used as the discount rate.