Deck 7: Share Valuation: the Dividend-Discount Model

Question 1

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

Answer 1

I and II

Question 2

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)1.47 million
B)59 billion
C)1.73 billion
D)89.3 billion

Answer 2

1.73 billion

Question 3

The below screen shot from Google Finance shows basic stock information for PepsiCo, Inc. If you owned 2 000 shares of PepsiCo, Inc. for the period shown (one quarter), how much would you have received in dividend payments?

A)$430
B)$3 040
C)$810
D)$1 620

Answer 3

$1 620

Question 4

Dividends are periodic cash flows given out by the firm to shareholders. It is not necessary for a firm to declare dividends but mature firms tend to pay out dividends.

Question 5

The Magnificent Corporation is expected to pay a dividend of $0.85 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 6.1%, what price would an investor be expected to pay per share five years into the future?

A)$13.43
B)$13.93
C)$12.65
D)$11.23

Question 6

Use the figure for the question(s)below.
The above screen shot from Google Finance shows the price history of Nektar, a pharmaceutical company. In the time period shown, Nektar released information that an intravenously administered formulation of their leading product had thrived in a Phase III clinical trial. In which of the months shown in the price history is this most likely to have occurred?

A)March 2017
B)April 2017
C)May 2017
D)February 2017

Question 7

The Busy Bee Corporation had a share price at the start of the year of $25.18, paid a dividend of $0.62 at the end of the year, and had a share price of $27.91 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 Busy Bee Corporation for this period?

A)17%
B)13%
C)15%
D)10%

Question 8

'Dividend payments' are 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.

Question 9

Use the figure for the question(s)below.
The above screen shot from Google Finance shows the basic stock information for Wesfarmers Ltd. ("WES")after the close of the ASX on 11 September 2017. What is the highest price WES has traded at in the last 12 months?

A)$41.50
B)$45.49
C)$41.45
D)$41.32

Question 10

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

Question 11

Valorous Corporation will pay a dividend of $1.80 per share at this year's end and a dividend of $2.40 per share at the end of next year. It is expected that the price of Valorous' stock will be $44 per share after two years. If Valorous has an equity cost of capital of 8%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today?

A)$39.27
B)$41.45
C)$40.22
D)$42.40

Question 12

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

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

Question 13

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

Question 14

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 15

Matilda Industries pays a dividend of $2.45 per share and is expected to pay this amount indefinitely. If Matilda's equity cost of capital is 7%, which of the following would be expected to be closest to Matilda's share price?

A)$32.25
B)$21.98
C)$35.00
D)$21.42

Question 16

A share is bought for $20.00 and sold for $24.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction?

A)1.27%
B)14.00%
C)20.00%
D)25.00%

Question 17

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 18

Use the figure for the question(s)below.
The below screen shot from Google Finance shows the basic stock information for the Commonwealth Bank of Australia after the close of business on 11 September 2017. How many shares of CBA had been traded on the ASX on this date?

A)4 billion
B)4.83 billion
C)4.83 million
D)5.9 billion

Question 19

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

Question 20

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 10 years in the future?

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

Question 21

Which of the following statements is FALSE?

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

Question 22

NoGrowth Industries presently pays an annual dividend of $1.70 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 14%, then the value of a share of NoGrowth is closest to:

A)$12.00
B)$11.33
C)$11.55
D)$11.00

Question 23

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)$8.00
C)$32.00
D)$24.00

Question 24

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

Question 25

A company can increase its dividend payments by issuing more shares.

Question 26

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

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

Question 27

A firm must pay its earnings out to its investors.

Question 28

Which of the following statements is FALSE?

A)Successful young firms often have high initial earnings growth rates.
B)A firm can only pay out its earnings to investors or reinvest its earnings.
C)According to the constant dividend growth model, the value of the firm depends on the current dividend level divided by the equity cost of capital plus the grow rate.
D)Estimating dividends, especially for the distant future, is difficult.

Question 29

Which of the following formulas is INCORRECT?

A)Div_t = × Dividend Payout Rate
B)earnings growth rate = retention rate x return on new investment
C)P₀ = +
+ ... +
+
×

D)P_N =

Question 30

Forecasting dividends does not require forecasting the firm's future earnings.

Question 31

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)If a firm wants to increase its share price, it must cut its dividend and invest more.
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)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).

Question 32

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

Question 33

Which of the following statements is FALSE?

A)A common approximation is to assume that in the long run, dividends will grow at a constant rate.
B)During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.
C)There is a tremendous amount of uncertainty associated with any forecast of a firm's future dividends.
D)The dividend each year is the firm's earnings per share (EPS)multiplied by its dividend payout rate.

Question 34

Which of the following statements is FALSE?

A)Total return equals earnings multiplied by the dividend payout rate.
B)As firms mature, their earnings exceed their investment needs and they begin to pay dividends.
C)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).
D)We cannot use the constant dividend growth model to value the shares of a firm with rapid or changing growth.

Question 35

Which of the following formulas is INCORRECT?

A)g = retention rate × return on new investment
B)P₀ =
C)Div_t = EPS_t × Dividend Payout Rate
D)r_E = + g

Question 36

Von Bora Corporation (VBC)is expected to pay a $2.25 dividend at the end of this year. If you expect VBC's dividend to grow by 6.5% per year forever and VBC's equity cost of capital is 12.5%, then the value of a share of VBC is closest to:

A)$37.50
B)$40.00
C)$51.10
D)$35.40

Question 37

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

Question 38

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

Question 39

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)8%
C)4%
D)2%

Question 40

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 is closest to:

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

Question 41

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

Question 42

On 15 June 2016, shares in CliffCo were trading at $15. Later that day, the company announced that its profits for the six months to 30 June 2016 would be 5% lower than the corresponding period the year before. At the close of trading on 16 June 2016, the price of CliffCo shares had fallen to $12.71 per share, and by 19 June 2016, the price was $11.80 per share. On 3 November 2016, 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 43

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)$43.50
C)$27.75
D)$10.75

Question 44

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

Question 45

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

Question 46

Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend 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)$30.22
B)$34.29
C)$23.97
D)$24.00

Question 47

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

Question 48

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

Question 49

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

Question 50

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

Question 51

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)$93.33
C)$140.00
D)$22.40

Question 52

Can the dividend-discount model handle negative growth rates?

Question 53

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)$70.05
C)$56.60
D)$10.51

Question 54

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

Question 55

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

Question 56

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 57

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

Question 58

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

Question 59

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

Question 60

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

Question 61

On 15 June 2016, shares in CliffCo were trading at $15. Later that day, the company announced that its profits for the six months to 30 June 2016 would be 5% lower than the corresponding period the year before. At the close of trading on 16 June 2016, the price of CliffCo shares had fallen to $12.71 per share, and by 19 June 2016, the price was $11.80 per share. On 3 November 2016, the price was $9.40 per share. How could CliffCo shares suddenly be worth 15% less after their announcement in June 2016?