Deck 7: Share Valuation: the Dividend-Discount Model

Question 1

The Sisyphean Company is currently trading for $25.00 per share. The company is expected to pay a $2.50 dividend at the end of the year and its equity cost of capital is 14%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Sisyphean Company's earnings is closest to:

A) 6%
B) 4%
C) 8%
D) 2%

Answer 1

4%

Question 2

Which of the following statements is FALSE?

A) The simplest forecast for the firm's future dividends states that they will grow at a constant rate, i.e., forever.
B) As firms mature, their growth slows to rates more typical of established companies.
C) We cannot use the general dividend-discount model to value the stock of a firm with rapid or changing growth.
D) The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders.

Answer 2

We cannot use the general dividend-discount model to value the stock of a firm with rapid or changing growth.

Question 3

Aaron Inc. has 316 million shares outstanding. It expects earnings at the end of the year to be $602 million. The firm's equity cost of capital is 11.5%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaron's earnings are expected to grow at a constant 6% per year, what is Aaron's share price?

A) $34.64
B) $8.66
C) $25.98
D) $17.32

Answer 3

$17.32

Question 4

Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If the current price of Coolibah shares is $22.40, and Coolibah's equity cost of capital is 16%, what price would you expect Coolibah's shares to sell for at the end of three years?

A) $29.34
B) $26.74
C) $31.36
D) $28.82

Question 5

Jumbuck Exploration has a current stock price of $2.00 and is expected to sell for $2.10 in one year'stime, immediately after it pays a dividend of $0.26. Which of the following is closest to Jumbuck Exploration's equity cost of capital?

A) 12%
B) 22%
C) 9%
D) 18%

Question 6

Valence Electronics has 217 million shares on issue. It expects earnings at the end of the year of $760 million. Valence pays out 40% of its earnings in total - 15% paid out as dividends and 25% used to repurchase shares. If Valence's earnings are expected to grow by 6% per year, these payout rates do not change, and Valence's equity cost of capital is 8%, what is Valence's share price?

A) $24.40
B) $56.60
C) $70.05
D) $10.51

Question 7

A company is expected to pay a dividend of $3.20 per share every year indefinitely and the equity cost of capital for the company is 10%. What price would an investor be expected to pay per share next year?

A) $16.00
B) $24.00
C) $32.00
D) $8.00

Question 8

Use the figure for the question(s) below

The above screen shot from Google Finance shows the basic stock information for the Commonwealth Bank of Australia. How many Commonwealth Bank shares are on issue?

A) 1.53 billion
B) 89.3 billion
C) 59 billion
D) 1.4 million

Question 9

Gremlin Industries will pay a dividend of $1.80 per share this year. It is expected that this dividend will grow by 4% per year each year in the future. The current price of a Gremlin share is $22.40. What is Gremlin's equity cost of capital?

A) 12%
B) 16%
C) 14%
D) 11%

Question 10

A company costs $42.00 per share and pays a dividend of $2.50 per share this year. The company's cost of equity is 8%. What is the expected annual growth rate of the company's dividends?

A) 11%
B) 8%
C) 4%
D) 2%

Question 11

Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that thisdividend will grow by 3% per year each year in the future. What will be the current value of a single Spacefood share if the firm's equity cost of capital is 10%?

A) $24.00
B) $30.22
C) $23.97
D) $34.29

Question 12

NoGrowth Industries presently pays an annual dividend of $1.50 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 12%, then the value of a share of NoGrowth is closest to:

A) $14.00
B) $10.00
C) $12.50
D) $15.00

Question 13

Chittenden Enterprises has 632 million shares on issue. It expects earnings at the end of the year to be $940 million. The firm's equity cost of capital is 10%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittenden's earnings are expected to grow at a constant 4% per year, what is Chittenden's share price?

A) $14.88
B) $3.36
C) $7.44
D) $4.96

Question 14

Sunnyfax Publishing pays out all its earnings and has a share price of $38. In order to expand? Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 12%. If the reinvestment does not affect Sunnyfax's equity cost of capital, what is the expected share price as a consequence of this decision?

A) $33.33
B) $50.00
C) $60.00
D) $40.00

Question 15

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $5.6 million. Sultan pays out 60% of its earnings in total-40% paid out as dividends and 20% used to repurchase shares. If Sultan's earnings are expected to grow by 7% per year, these payout rates do not change, and Sultan's equity cost of capital is 9%, what is Sultan's share price?

A) $56.00
B) $140.00
C) $22.40
D) $93.33

Question 16

A share is bought for $22.00 and sold for $26.00 one year later, immediately after it has paid adividend of $1.50. What is the capital gain rate for this transaction?

A) 15.00%
B) 18.18%
C) 0.27%
D) 4.00%

Question 17

You expect KT Industries (KTI) will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 15% and their equity cost of capital is 12%. The value of a share of KTI is closest to:

A) $39.25
B) $12.50
C) $20.00
D) $33.35

Question 18

Rylan Industries is expected to pay a dividend of $5.20 per share for the next four years. If the current price of Rylan stock is $32.63, and Rylan's equity cost of capital is 14%, what price would you expect Rylan's stock to sell for at the end of the four years?

A) $55.11
B) $29.52
C) $80.70
D) $25.58

Question 19

Matilda Industries pays a dividend of $2.25 per share and is expected to pay this amount indefinitely. If Matilda's equity cost of capital is 12%, which of the following would be expected to be closest to Matilda's share price?

A) $21.98
B) $18.75
C) $14.65
D) $12.25

Question 20

Which of the following statements is FALSE regarding profitable and unprofitable growth?

A) A firm can increase its growth rate by retaining more of its earnings.
B) Cutting the firm's dividend to increase investment will raise the share price if, and only if, the new investments have a positive net present value (NPV).
C) If the firm retains more earnings, it will be able to pay out less of those earnings, which means that the firm will have to reduce its dividend.
D) If a firm wants to increase its share price, it must cut its dividend and invest more.

Question 21

Use the figure for the question(s) below.

The above screen shot from Google Finance shows the price history of Progenics, a pharmaceutical company. In the time period shown, Progenics released information that an intravenously administered formulation of their leading product had failed in a Phase III clinical trial. In which of the months shown in the price history is this most likely to have occurred?

A) February 2008
B) April 2008
C) May 20008
D) March 2008

Question 22

Which of the following situations is a potential source of cash flows for shareholders?
I. The investor may be able to sell the shares at a future date.
II. The firm in which the shares are held might pay out cash to shareholders in the form of dividends.
III. The firm in which the shares are held might increase the value of its shares by reducing the total number of shares outstanding.

A) I only
B) II only
C) I and II
D) II and III

Question 23

Use the figure for the question(s) below

The above screen shot from Google Finance shows the basic stock information for the Commonwealth Bank of Australia after the close of business on 12 April 2010. How many shares of CBA had been traded on the ASX on this date?

A) 1.4 million
B) 89 billion
C) 1.3 billion
D) 59 billion

Question 24

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Bean's equity cost of capital is 12%, then the price of a share of Bean Enterprises is closest to:

A) $17.00
B) $27.75
C) $10.75
D) $43.50

Question 25

Avril Synchronistics will pay a dividend of $1.30 per share this year. It is expected that this dividend will grow by 5% each year in the future. What will be the current value of a single Avril share if the firm's equity cost of capital is 14%?

A) $15.16
B) $9.23
C) $14.44
D) $9.28

Question 26

Use the figure for the question(s) below

The above screen shot from Google Finance shows the basic stock information for Pacific Brands Limited after the close of the ASX on 7 April 2010. What is the highest price PBG has traded at in the last 12 months?

A) $1.45
B) $1.52
C) $1.50
D) $1.32

Question 27

Which of the following models can be used to value a firm without explicitly forecasting that firm's dividends, share repurchases, or its use of debt? I. Dividend-discount model II. Total payout model III. Discounted free cash flow model

A) I only
B) II only
C) III only
D) II and III

Question 28

Credenza Industries is expected to pay a dividend of $1.20 at the end of the coming year. It is expected to sell for $62.00 at the end of the year. If its equity cost of capital is 8%, what is the expected capital gain from the sale of this share at the end of the coming year?

A) $58.52
B) $3.48
C) $14.28
D) $4.86

Question 29

Kirkevue Industries pays out all its earnings as dividends and has a share price of $24. In order to expand, Kirkevue announces it will cut its dividend payments from $2.00 to $1.80 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged?

A) 17.97%
B) 15.33%
C) 0.83%
D) 18.23%

Question 30

Which of the following is NOT a method by which a company can increase its dividend payments?

A) It can issue more shares.
B) It can increase its dividend payout rate.
C) It can increase its earnings.
D) It can decrease the number of shares outstanding.

Question 31

The Busby Corporation had a share price at the start of the year of $26.20, paid a dividend of $0.56 at the end of the year, and had a share price of $29.00 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period?

A) 7%
B) 13%
C) 9%
D) 5%

Question 32

Von Bora Corporation (VBC) is expected to pay a $2.00 dividend at the end of this year. If you expect VBC's dividend to grow by 5% per year forever and VBC's equity cost of capital is 13%, then the value of a share of VBC is closest to:

A) $15.40
B) $25.00
C) $40.00
D) $11.10

Question 33

A company has a current share price of $14.50 and is expected to pay a $0.85 dividend in one year. If the company's equity cost of capital is 12%, what price would its shares be expected to sell for immediately after it pays the dividend?

A) $12.18
B) $15.39
C) $13.65
D) $15.29

Question 34

Which of the following is NOT a way that a firm can increase its dividend?

A) by decreasing its shares outstanding
B) by increasing its dividend payout rate
C) by increasing its retention rate
D) by increasing its earnings (net income)

Question 35

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 12%. Luther Industries' dividends are expected to grow at a constant rate indefinitely. The growth rate of Luther's dividends are closest to:

A) 12%
B) 16.5%
C) 7.5%
D) 5.5%

Question 36

A company is expected to pay a dividend of $1.25 per share every year indefinitely and the equity cost of capital for the company is 7.5%. What price would an investor be expected to pay per share ten years in the future?

A) $16.67
B) $33.34
C) $41.68
D) $25.01

Question 37

Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.50 in the coming year. It decides to retain 20% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 12%, what is the expected share price of Jumbo Transport?

A) $24.75
B) $28.57
C) $16.67
D) $19.23

Question 38

A company is expected to pay a dividend of $0.80 per share every year indefinitely. If the current price of the share is $18.90, and the equity cost of capital for the company is 6.4%, what price would an investor be expected to pay per share five years into the future?

A) $21.23
B) $20.43
C) $12.50
D) $22.65

Question 39

JRN Enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRN's dividends were expected to grow at 4% per year and JRN shares were trading at $25.00 per share. With the new expansion, JRN's dividends are expected to grow at 8% per year indefinitely. Assuming that JRN's risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to:

A) $27.50
B) $31.25
C) $25.00
D) $15.00

Question 40

You expect KT Industries (KTI) will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 15% and their equity cost of capital is 12%. The expected growth rate for KTI's dividends is closest to:

A) 6.0%
B) 4.5%
C) 7.5%
D) 3.0%

Question 41

Assuming everything else remains unchanged, how does a firm's decision to increase its dividend payout ratio affect its growth rate?

Question 42

On 15 June 2012, shares in CliffCo were trading at $15. Later that day the company announced that its profits for the six months to 30 June 2012 would be 5% lower than the corresponding period the year before. At the close of trading on 16 June 2012, the price of CliffCo shares had fallen to $12.71 per share, and by 19 June 2012, the price was $11.80 per share. On 3 November 2012 the price was $9.40 per share. How could CliffCo shares suddenly be worth 15% less after their announcement in June 2012?

Question 43

Stocks that do not pay a dividend must have a value of $0?

Question 44

What are dividend payments?

A) a part share of the profits or earnings of a company paid to each shareholder on the basis of the number of shares they hold
B) the difference between the original cost price of a share and the price an investor receives when that share is sold
C) payments made to a company by investors for a share of the ownership of that company
D) incremental increases in the value of the stock held by an investor due to rises in share price

Question 45

An ordinary share is a share in the ownership of a corporation, which carries rights to share in the profits of the firm through future dividend payments.

Question 46

The Valuation Principle states that the value of a share is equal to the present value (PV) of both the dividends and future sale price of that share which the investor will receive.

Question 47

How can the dividend-discount model handle changing growth rates?

Question 48

A firm can either pay its earnings out to its investors or it can keep them and reinvest them?

Question 49

What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?

Question 50

What role do dividends play in share investing?

Question 51

Use the figure for the question(s) below.

The above screen shot from Google Finance shows basic stock information for Leighton Holdings. If you owned 2000 shares of Leighton Holdings for the period shown, how much would you have received in dividend payments?

A) $1200.00
B) $6340.00
C) $414.00
D) $120.00

Question 52

On 15 June 2012, shares in CliffCo were trading at $15. Later that day the company announced that its profits for the six months to 30 June 2012 would be 5% lower than the corresponding period the year before. At the close of trading on 16 June 2012, the price of CliffCo shares had fallen to $12.71 per share, and by 19 June 2012, the price was $11.80 per share. On 3 November 2012 the price was $9.40 per share. How might an investor decide whether to buy or sell a share of CliffCo at this price?

Question 53

What is a major assumption about growth rate in the dividend-discount model?

Question 54

Forecasting dividends requires forecasting the firm's future earnings?

Question 55

Can the dividend-discount model handle negative growth rates?