Question 1

Motor Homes Inc. (MHI) is presently in a stage of abnormally high growth because of a surge in the demand for motor homes. The company expects earnings and dividends to grow at a rate of 20 percent for the next 4 years, after which time there will be no growth (g = 0) in earnings and dividends. The company's last dividend was $1.50. MHI's beta is 1.6, the return on the market is currently 12.75 percent, and the risk-free rate is 4 percent. What should be the current price per share of common stock?

Accepted Answer

A)   $15.17
B)   $17.28
C)   $22.21
D)   $19.10
E)   $24.66 A

Question 2

As financial manager of Material Supplies Inc., you have recently participated in an executive committee decision to enter into the plastics business. Much to your surprise, the price of the firm's common stock subsequently declined from $40 per share to $30 per share. While there have been several changes in financial markets during this period, you are anxious to deter¬mine how the market perceives the relevant risk of your firm. Assume that the market is in equilibrium. From the following data you find that the beta value associated with your firm has changed from an old beta of to a new beta of _. (1)(2)(3)(4) The next dividend, D1, was expected to be $2 per share, assuming the "old" 5 percent growth rate.

Accepted Answer

A)   2.00; 1.50
B)   1.50; 3.00
C)   2.00; 3.17
D)   1.67; 2.00
E)   1.50; 1.67 C

Question 3

If the expected rate of return on a stock exceeds the required rate,

Accepted Answer

A)   The stock is experiencing supernormal growth.
B)   The stock should be sold.
C)   The company is probably not trying to maximize price per share.
D)   The stock is a good buy.
E)   Dividends are not being declared. D

Question 4

Ceejay Corporation's stock is currently selling at an equilibrium price of $30 per share. The firm has been experiencing a 6 percent annual growth rate. Last year's earnings per share, E0, were $4.00 and the dividend payout ratio is 40 percent. The risk-free rate is 8 percent, and the market risk premium is 5 percent. If market risk (beta) increases by 50 percent, and all other factors remain constant, what will be the new stock price? (Use 4 decimal places in your calculations.)

Accepted Answer

A)   $16.59
B)   $18.25
C)   $21.39
D)   $22.69
E)   $53.48

Question 5

The Hart Mountain Company has recently discovered a new type of kitty litter which is extremely absorbent. It is expected that the firm will experience (begin¬ning now) an unusually high growth rate (20 percent) during the period (3 years) it has exclusive rights to the property where the raw material used to make this kitty litter is found. However, beginning with the fourth year the firm's competition will have access to the material, and from that time on the firm will achieve a normal growth rate of 8 percent annually. During the rapid growth period, the firm's dividend payout ratio will be relatively low (20 percent) in order to conserve funds for reinvest¬ment. However, the decrease in growth in the fourth year will be accom¬panied by an increase in dividend payout to 50 percent. Last year's earnings were E0 = $2.00 per share, and the firm's required return is 10 percent. What should be the current price of the common stock?

Accepted Answer

A)   $66.50
B)   $87.96
C)   $71.53
D)   $61.78
E)   $93.50

Question 6

If security markets were truly strong-form efficient, you would never be able to realize a rate of return on a security greater than the marginal investor's expected (or required) rate of return.

Accepted Answer

A) True 
 B)False

Question 7

Albright Motors is expected to pay a year-end dividend of $3.00 a share (D1 = $3.00). The stock currently sells for $30 a share. The required (and expected) rate of return on the stock is 16 percent. If the dividend is expected to grow at a constant rate, g, what is g?

Accepted Answer

A)   13.00%
B)   10.05%
C)   6.00%
D)   5.33%
E)   7.00%

Question 8

Carlson Products, a constant growth company, has a current market (and equilibrium) stock price of $20.00. Carlson's next dividend, D1, is forecasted to be $2.00, and Carlson is growing at an annual rate of 6 percent. Carlson has a beta coefficient of 1.2, and the required rate of return on the market is 15 percent. As Carlson's financial manager, you have access to insider information concerning a switch in product lines which would not change the growth rate, but would cut Carlson's beta coefficient in half. If you buy the stock at the current market price, what is your expected percentage capital gain?

Accepted Answer

A)   23%
B)   33%
C)   43%
D)   53%
E)   There would be a capital loss.

Question 9

A stock's dividend is expected to grow at a constant rate of 5 percent a year. Which of the following statements is most correct?

Accepted Answer

A)   The expected return on the stock is 5 percent a year.
B)   The stock's dividend yield is 5 percent.
C)   The stock's price one year from now is expected to be 5 percent higher.
D)   Statements a and c are correct.
E)   All of the statements above are correct.

Question 10

The last dividend paid by Klein Company was $1.00. Klein's growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent forever. Klein's required rate of return on equity (rs) is 12 percent. What is the current price of Klein's common stock?

Accepted Answer

A)   $21.00
B)   $33.33
C)   $42.25
D)   $50.16
E)   $58.75

Question 11

Given the following information, calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.6; rM = 15%; rRF = 8%; D1 = $2.00; P0 = $25.00. Assume the stock is in equilibrium and exhibits constant growth.

Accepted Answer

A)   3.8%
B)   0%
C)   8.0%
D)   4.2%
E)   2.5%

Question 12

Most studies of stock market efficiency suggest that the stock market is highly efficient in the weak form and reasonably efficient in the semistrong form. Based on these findings which of the following statements are correct?

Accepted Answer

A)   Information you read in The Wall Street Journal today cannot be used to select stocks that will consistently beat the market.
B)   The stock price for a company has been increasing for the past 6 months. Based on this information it must be true that the stock price will also increase during the current month.
C)   Information disclosed in companies' most recent annual reports can be used to consistently beat the market.
D)   Statements a and c are correct.
E)   All of the statements above are correct.

Question 13

You are given the following data: (1) The risk-free rate is 5 percent.
(2) The required return on the market is 8 percent.
(3) The expected growth rate for the firm is 4 percent.
(4) The last dividend paid was $0.80 per share.
(5) Beta is 1.3.
Now assume the following changes occur:
(1) The inflation premium drops by 1 percent.
(2) An increased degree of risk aversion causes the required return on the market to go to 10 percent after adjusting for the changed inflation premium.
(3) The expected growth rate increases to 6 percent.
(4) Beta rises to 1.5.What will be the change in price per share, assuming the stock was in equilibrium before the changes?

Accepted Answer

A)   +$12.11
B)   -$ 4.87
C)   +$ 6.28
D)   -$16.97
E)   +$ 2.78

Question 14

Philadelphia Corporation's stock recently paid a dividend of $2.00 per share (D0 = $2), and the stock is in equilibrium. The company has a constant growth rate of 5 percent and a beta equal to 1.5. The required rate of return on the market is 15 percent, and the risk-free rate is 7 percent. Philadelphia is considering a change in policy which will increase its beta coefficient to 1.75. If market conditions remain unchanged, what new constant growth rate will cause the common stock price of Philadelphia to remain unchanged?

Accepted Answer

A)   8.85%
B)   18.53%
C)   6.77%
D)   5.88%
E)   13.52%

Question 15

Which of the following statements is most correct?

Accepted Answer

A)   One of the advantages to the firm associated with financing using preferred stock rather than common stock is that control of the firm is not diluted.
B)   Preferred stock provides steadier and more reliable income to investors than common stock.
C)   One of the advantages to the firm of financing with preferred stock is that 70 percent of the dividends paid out are tax deductible.
D)   Statements a and c are correct.
E)   Statements a and b are correct.

Question 16

NOPREM Inc. is a firm whose shareholders don't possess the preemptive right. The firm currently has 1,000 shares of stock outstanding; the price is $100 per share. The firm plans to issue an additional 1,000 shares at $90.00 per share. Since the shares will be offered to the public at large, what is the amount per share that old shareholders will lose if they are excluded from purchasing new shares?

Accepted Answer

A)   $90.00
B)   $ 5.00
C)   $10.00
D)   $ 0
E)   $ 2.50

Question 17

Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. Your expectations are that you will not receive a dividend at the end of Year 1, but you will receive a dividend of $9.25 at the end of Year 2. In addition, you expect to sell the stock for $150 at the end of Year 2. If your expected rate of return is 16 percent, how much should you be willing to pay for this stock today?

Accepted Answer

A)   $164.19
B)   $ 75.29
C)   $107.53
D)   $118.35
E)   $131.74

Question 18

R) E. Lee recently took his company public through an initial public offering. He is expanding the business quickly to take advantage of an otherwise unexploited market. Growth for his company is expected to be 40 percent for the first three years and then he expects it to slow down to a constant 15 percent. The most recent dividend (D0) was $0.75. Based on the most recent returns, the beta for his company is approximately 1.5. The risk-free rate is 8 percent and the market risk premium is 6 percent. What is the current price of Lee's stock?

Accepted Answer

A)   $77.14
B)   $75.17
C)   $67.51
D)   $73.88
E)   $93.20

Question 19

Mack Industries just paid a dividend of $1.00 per share , and 15 percent next year. After two years the dividend is expected to grow at a constant rate of 5 percent. The required rate of return on the company's stock is 12 percent. What should be the current price of the company's stock?

Accepted Answer

A)   $12.33
B)   $16.65
C)   $16.91
D)   $18.67
E)   $19.67

Question 20

Modular Systems Inc. just paid dividend D0, and it is expecting both earnings and dividends to grow by 0 percent in Year 2, by 5 percent in Year 3, and at a rate of 10 percent in Year 4 and thereafter. The required return on Modular is 15 percent, and it sells at its equili-brium price, P0 = $49.87. What is the expected value of the next dividend, D1? (Hint: Draw a time line and then set up and solve an equation with one unknown, D1.)

Accepted Answer

A)   It cannot be estimated without more data.
B)   $1.35
C)   $1.85
D)   $2.35
E)   $2.85

Exam 5: Basic Stock Valuation