Chapter 18 Equity Valuation Models
31. A preferred stock will pay a dividend of $7.50 in the upcoming year, and every year
thereafter, i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.
A) $0.75 B) $7.50 C) $64.12 D) $56.25 E) none of the above
Answer: E Difficulty: Moderate
Rationale: 7.50 / .10 = 75.00
32. A preferred stock will pay a dividend of $6.00 in the upcoming year, and every year
thereafter, i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.
A) $0.60 B) $6.00 C) $600 D) $5.40 E) none of the above
Answer: E Difficulty: Moderate
Rationale: 6.00 / .10 = 60.00
33. You are considering acquiring a common stock that you would like to hold for one year.
You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.
A) $30.23 B) $24.11 C) $26.52 D) $27.50 E) none of the above
Answer: A Difficulty: Moderate
Rationale: .10 = (32 - P + 1.25) / P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.
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34. You are considering acquiring a common stock that you would like to hold for one year.
You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return.
A) $23.91 B) $14.96 C) $26.52 D) $27.50 E) none of the above
Answer: B Difficulty: Moderate
Rationale: .12 = (16 - P + 0.75) / P; .12P = 16 - P + 0.75; 1.12P = 16.75; P = 14.96.
35. You are considering acquiring a common stock that you would like to hold for one year.
You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return.
A) $23.91 B) $24.11 C) $26.52 D) $27.50 E) none of the above
Answer: C Difficulty: Moderate
Rationale: .15 = (28 - P + 2.50) / P; .15P = 28 - P + 2.50; 1.15P = 30.50; P = 26.52.
36. You are considering acquiring a common stock that you would like to hold for one year.
You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.
A) $23.91 B) $24.11 C) $26.52 D) $27.50 E) none of the above
Answer: E Difficulty: Moderate
Rationale: .10 = (42 - P + 3.50) / P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.
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Use the following to answer questions 37-40:
Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities and $45 million in common shareholders' equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90.
37. What is Paper Express's book value per share? A) $1.68 B) $2.60 C) $32.14 D) $60.71 E) none of the above
Answer: C Difficulty: Moderate
Rationale: $45M/1.4M = $32.14.
38. What is Paper Express's market value per share? A) $1.68 B) $2.60 C) $32.14 D) $60.71 E) none of the above
Answer: E Difficulty: Easy
39. What is Paper Express's replacement cost per share? A) $1.68 B) $2.60 C) $53.57 D) $60.71 E) none of the above
Answer: C Difficulty: Moderate
Rationale: $115M - 40M/1.4M = $53.57.
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40. What is Paper Express's Tobin's q? A) 1.68 B) 2.60 C) 53.57 D) 60.71 E) none of the above
Answer: A Difficulty: Moderate
Rationale: $90/ 53.57 = 1.68
41. One of the problems with attempting to forecast stock market values is that A) there are no variables that seem to predict market return. B) the earnings multiplier approach can only be used at the firm level. C) the level of uncertainty surrounding the forecast will always be quite high. D) dividend payout ratios are highly variable. E) none of the above.
Answer: C Difficulty: Easy
Rationale: Although some variables such as market dividend yield appear to be strongly
related to market return, the market has great variability and so the level of uncertainty in any forecast will be high.
42. The most popular approach to forecasting the overall stock market is to use A) the dividend multiplier. B) the aggregate return on assets. C) the historical ratio of book value to market value. D) the aggregate earnings multiplier. E) Tobin's Q.
Answer: D Difficulty: Easy
Rationale: The earnings multiplier approach is the most popular approach to forecasting
the overall stock market.
Use the following to answer questions 43-44:
Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25.
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43. The market's required rate of return on Sure's stock is _____. A) 14.0% B) 17.5% C) 16.5% D) 15.25% E) none of the above
Answer: C Difficulty: Moderate
Rationale: 4% + 1.25(14% - 4%) = 16.5%.
44. What is the intrinsic value of Sure's stock today? A) $20.60 B) $20.00 C) $12.12 D) $22.00 E) none of the above
Answer: A Difficulty: Difficult
Rationale: k = .04 + 1.25 (.14 - .04); k = .165; .165 = (22 - P + 2) / P; .165P = 24 - P;
1.165P = 24 ; P = 20.60.
45. If Sure's intrinsic value is $21.00 today, what must be its growth rate? A) 0.0% B) 10% C) 4% D) 6% E) 7%
Answer: E Difficulty: Difficult
Rationale: k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07
Use the following to answer questions 46-47:
Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2.
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