Deck 10: Stock Valuation

Question 1

________ gives minority shareholders more power to elect a member to the board of directors.

A) Preemptive right
B) Majority voting
C) Proxy fights
D) Cumulative voting

Answer 1

D

Question 2

P. Noel Company's common stock has just paid a $2.00 dividend. If investors believe that the expected rate of return on P. Noel is 14% and that dividends will grow at the rate of 5% per year for the foreseeable future, what is the value of a share of P. Noel stock?

A) $15.00
B) $22.22
C) $23.33
D) $40.00

Answer 2

C

Question 3

Nicholas Inc. just paid a $2.00 dividend on its common stock and expects to continue growing dividends at an average rate of 5% each year, from now to infinity. If the required rate of return for this stock is 9% and it is currently selling for $54.50 per share, the stock

A) selling for exactly its intrinsic value.
B) there is not information to determine if the stock is overpriced or underpriced.
C) underpriced.
D) overpriced.

Answer 3

D

Question 4

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?

A) 4.08%
B) 8.00%
C) 12.00%
D) 8.80%

Question 5

Evidence that agency costs exists

A) because they are shown in footnotes to the financial statements.
B) because stock prices increase when an underperforming CEO is unexpectedly replaced.
C) because underperforming CEO's are frequently voted out by shareholders.
D) because management often pursues risky but profitable opportunities rather than safer, less profitable opportunities.

Question 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?

A) 40%
B) 50%
C) 60%
D) 70%

Question 7

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?

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

Question 8

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.

A) $1
B) $3
C) $5
D) $7

Question 9

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

A) $36.36.
B) $38.18.
C) $33.06.
D) $34.88.

Question 10

Evidence exists that directors

A) aggressively represent the interests of shareholders.
B) are quick to replace or reduce the compensation of underperforming CEOs.
C) often represent the interests of the managers who nominated them for directorships.
D) are vigilant in requiring that the firm's assets be used efficiently.

Question 11

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.

A) $36.65
B) $91.23
C) $51.55
D) $74.82

Question 12

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

A) 4.80%.
B) 7.20%.
C) 12%.
D) 6%.

Question 13

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.

A) $4.91
B) $5.40
C) $9.80
D) $6.80

Question 14

Frost Corporation's recent earnings per share were $12.90. Their dividend payout ratio is 20%. Earnings are expected to grow at an average of 6% per year and the company's policy is to maintain the same payout ratio. If investors are requiring a 12% rate of return on this stock, what will they be willing to pay for one share?

A) $21.50
B) $22.75
C) $43.00
D) $45.58

Question 15

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?

A) 4.25%
B) 22.67%
C) 44.12%
D) 12.75%

Question 16

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

A) growth rate
B) required rate of return
C) last paid dividend
D) both B and C

Question 17

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?

A) (D1 + g)/Vc
B) D1/Vc + g
C) D1/g
D) D1/Vc

Question 18

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

A) agency problem.
B) preemptive right.
C) majority voting feature.
D) proxy fights.

Question 19

Common stockholders are essentially

A) creditors of the firm.
B) managers of the firm.
C) owners of the firm.
D) all of the above.

Question 20

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.

A) 10%
B) 33%
C) 7%
D) 4.3%

Question 21

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.

A) 1%
B) 3%
C) 5%
D) 7%

Question 22

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?

A) $40
B) $10
C) $20.09
D) $0.00

Question 23

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

A) The majority voting provision
B) The casting feature
C) The cumulative voting provision
D) The proxy method

Question 24

Common stockholders are essentially creditors of the firm.

Question 25

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?

A) $57.51
B) $62.25
C) $71.86
D) $63.92

Question 26

Common stockholders expect greater returns than bondholders because

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

Question 27

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.

A) 3%
B) 5%
C) 8%
D) 10%

Question 28

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

Question 29

Common shareholders have a claim on the company's assets

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

Question 30

Common stock represents a claim on residual income.

Question 31

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

Question 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?

A) $12.60
B) $9.21
C) $17.12
D) $15.55
E) $11.46

Question 33

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

A) 5%.
B) 10.25%.
C) 13.11%.
D) 10%.

Question 34

When a company has an initial public offering

A) the previous owner of the shares will bet the money and the buyer will get the shares.
B) the proceeds of the sale will not affect the company's balance.
C) the proceeds of the sale will increase the company's equity.
D) the proceeds of the sale will become a liability payable to the shareholders.

Question 35

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

A) proxy fights.
B) cumulative voting.
C) call provisions.
D) majority voting.

Question 36

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

Question 37

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?

A) $100
B) $110
C) $120
D) $130

Question 38

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?

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

Question 39

If a company has issued preferred stock

A) the common shareholders will have weaker voting rights.
B) preferred shareholders will be allowed to choose one or more members of the board of directors.
C) dividends on preferred stock will be higher than the common dividends.
D) preferred dividends will have to be paid before the company can pay dividends on common stock.

Question 40

Which investor incurs the greatest risk?

A) Mortgage bondholder
B) Preferred stockholder
C) Common stockholder
D) Debenture bondholder

Question 41

Zorba's is a small chain 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 $1.21 per share and next year's earnings are forecasted at $1.46 per share. A reasonable price for a share of Zorba's stock is

A) $24.
B) $20.
C) $18.
D) $16.

Question 42

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

Question 43

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

Question 44

Home Depot stock is currently selling for $136 per share. Next year's dividend is expected to be $3.31; next year's earnings per share are expected to be $6.55. Home Depot's P/E ratio is

A) )048.
B) 22.03.
C) 20.75
D) 41.08

Question 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

Question 46

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

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

Question 47

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

A) $28.20.
B) $26.25.
C) $27.23.
D) $8.57.

Question 48

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?

Question 49

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?

Question 50

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

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

Question 51

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?

Question 52

The P/E ratio is calculated by dividing

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

Question 53

Cumulative voting allows a shareholder to cast all of his or her votes for one director rather than voting on each director separately.

Question 54

The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are using the average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next year is

A) $0.54.
B) $1.50.
C) $2.24
D) There is not enough information calculate earnings per share.

Question 55

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

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

Question 56

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?

Question 57

McDonald's stock currently sells for $123. It's expected earnings per share are $5.12. The average P/E ratio for the industry is 24. 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

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

Question 58

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?

Question 59

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

Question 60

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%.

Question 61

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?

A) $100
B) $75
C) $50
D) $25

Question 62

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?

Question 63

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?

A) 8.33%
B) 12.00%
C) 2.50%
D) 20.00%

Question 64

Apple stock is now selling for $115 per share. The P/E ratio based on current earnings is 13.77 and the P/E ratio based on expected earnings is 12.29. The expected growth rate in Apples earnings must be

A) 1.48%.
B) 12.1%.
C) -10.3%.
D) 10.3%.

Question 65

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?

A) $38.46
B) $26.26
C) $65.46
D) $46.38

Question 66

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?

A) $37.50
B) $15.00
C) $16.67
D) $6.00

Question 67

Piercing Publishers recently issued preferred stock with a fixed annual dividend of $3.00 per share. Investors require a 5% return on similar preferred stock issues. The stock is currently selling for $65. Is the stock a good buy?

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

Question 68

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

Question 69

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%.

A) 6.30%
B) 7.88%
C) 10.25%
D) 5.02%

Question 70

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

Question 71

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.

Question 72

Walmart's current earnings per share of $4.60 are expected to grow only at a rate of 2% per year for the next few years. Using a P/E ratio of 15, what is a reasonable value for a share of Walmart Stock.

Question 73

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

Question 74

Which of the following statements concerning preferred stock is correct?

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

Question 75

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.

A) $100
B) $85
C) $75
D) $16

Question 76

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

A) Cumulative dividends feature
B) Voting rights
C) Fixed dividend
D) Both A and C

Question 77

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.

A) 36.13%
B) 12.5%
C) 8.0%
D) 13.6%

Question 78

Which of the following statements is true?

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

Question 79

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?

A) $10
B) $15
C) $20
D) $25

Question 80

Edison Power and 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

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