b. $11.17 c. $14.22 d. $17.32 e. $30.90
Difficulty level: Challenge
DIFFERENTIAL GROWTH VALUATION
b 106. A stock you are interested in paid a dividend of $1 last year. The anticipated growth rate in
dividends and earnings is 20% for the next year and 10% the year after that before settling down to a constant 5% growth rate. The discount rate is 12%. Calculate the expected price of the stock.
a. $17.20 b. $17.90 c. $18.20 d. $19.40 e. $19.75 Difficulty level: Challenge
DIFFERENTIAL GROWTH VALUATION
c 107. A stock you are interested in paid a dividend of $1 last year. The anticipated growth rate in
dividends and earnings is 25% for the next 2 years before settling down to a constant 5% growth rate. The discount rate is 12%. Calculate the expected price of the stock.
a. $15.38 b. $20.50 c. $21.04 d. $22.27 e. $26.14 Difficulty level: Challenge
STOCK VALUATION
b 108. Which of the following values is closest to the amount that should be paid for a stock that will
pay a dividend of $10 in one year and $11 in two years? The stock will be sold in 2 years for an estimated price of $120. The appropriate discount rate is 9%.
a. $114.60 b. $119.40 c. $124.20 d. $129.50 e. $138.75
IV. ESSAYS
NYSE MEMBERS
109. List the four types of New York Stock Exchange members and give a brief definition of what each
member does. This is a simple listing question, the answer to which should include: 1. Commission broker: Executes customer orders to buy/sell stock as transmitted to the exchange
floor
2. Specialist (market maker): Acts as a dealer in a small number of securities on the exchange floor 3. Floor broker: Executes orders for commission brokers on a fee basis
4. Floor trader: Trades for their own account in an attempt to profit on temporary price fluctuations
NASDAQ VS. NYSE
110. What are the primary differences between NASDAQ and the NYSE? According to the basic information in the text, the NYSE has a physical location, while NASDAQ
does not. NASDAQ has multiple market makers while the NYSE utilizes specialists for each security traded. Also, NASDAQ is a dealer market while the NYSE utilizes brokers.
REQUIRED RETURN
111. What are the components of the required rate of return on a share of stock? Briefly explain each
component. The two components are dividend yield, which measures the annual percentage income return on a
stock, and the capital gains yield, which is the percentage of price appreciation or depreciation.
PREFERRED VS. COMMON STOCK
112. Briefly explain the differences between preferred and common stock. Common stockholders have the right to vote on corporate matters and have the right to receive the
residual value of the firm after all liabilities and preferred stockholders are paid in a liquidation. Preferred stockholders have a promised dividend, may or may not have the right to collect dividends that have been passed, and typically will be rated much like bonds. In a liquidation, preferred shareholders have a preference over common stockholders.
STOCKS VS. BONDS
113. Explain whether it is easier to find the required return on a publicly traded stock or a publicly traded
bond, and explain why. Bonds, unlike stocks, have a final maturity date and promised payments at fixed periods of time.
Thus, once an appropriate discount rate is established, valuing a bond is relatively simple. For stocks, the only valuation model we have up to this point in the text is the dividend growth model which requires estimation of a dividend growth rate and also requires that certain conditions be met before the dividend growth model can be applied. Normally, all of the information required to find the yield on a publicly traded bond is publicly available while only the price and the most current dividend are available for stocks.
ZERO-DIVIDEND STOCKS
114. A number of publicly traded firms pay no dividends yet investors are willing to buy shares in these
firms. How is this possible? Does this violate our basic principle of stock valuation? Explain. Our basic principle of stock valuation is that the value of a share of stock is simply equal to the
present value of all of the expected dividends on the stock. According to the dividend growth model, an asset that has no expected cash flows has a value of zero, so if investors are willing to purchase shares of stock in firms that pay no dividends, they evidently expect that the firms will begin paying dividends at some point in the future.
CLASSES OF STOCK
115. A firm has two classes of common stock outstanding: Class A, which carries voting rights of 10
votes per share but receives no dividends (ever), and Class B, which carries voting rights of 1 vote per share and pays dividends whenever they are declared by the board. Which would you be willing to pay more for and why? This is a very open-ended question to get the students thinking about the differing interests of
investors. Management of the firm would likely prefer Class A while investors interested in dividends would likely prefer Class B shares. The Class B shares with their ordinary voting rights and dividends can be valued using the dividend growth model but the Class A shares, whose value is derived completely from the voting rights, would be very difficult to value.
SOLUTIONS TO TEST BANK PROBLEMS
Chapter 6 59. 60. 61. 62. 63. 64. 65. 66.
P0?P0?P0?$2.16.10?.04; P0 = $36.00
; P0 = $20.80 ; P0 = $11.67 ; P1 = $55.13
$.80?(1?.04).08?.04.14?.05$1.00?(1?.05)P1?$2.00?(1?.05).09?.052P0?P0?$2.00.12$2.00.15; P0 = $16.67 ; P0 = $13.33
$1.80$25.71?R?.04; R = 11.00%
$2.205?$2.10$2.10.048 ? $2.10P0; P0 = $43.75; g?; g = .05;$43.75?$2.205R?.05;
R = 10.04%
67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78.
$62.10$22.00??$3.60?(1?.035)R?.035$2.42R?.025; R = 9.5%
; R = 13.50%
.12?D1P0?.08;Dividend yield = 4%
g = .1125 - .015 = .0975 = 9.75%
$21?D0?(1?.05).09?.05D1.12?.106; D0 = $.80
$60.50?; D1 = $1.21
D6?$.90?(1.03); D6 = $1.07 D0?.09?$31.11; D0 = $2.80 P0?$3.50.12; P0 = $29.17
; g = 6.3%
$2.08?(1?.04).08?.0410$39.86?$1.20?(1?g).095?gg?$2.08?$2.00$2.00; g = .04; D10?4; D10 = $76.97
P3?$1.20?(1?.025).10?.025; P3 = $17.66; Purchase cost = 100 ? $17.66 = $1,766
79. 80. 81.
P5?$1.60?(1?.035).12?.0355; P5 = $22.36
1$27.73?$1.60?(1?g).10?g; g = 4.00%
Dividends for the first 4 years are: $1.20, $1.44, $1.728, and $2.0736.
P4?P0?$2.0736?(1?.05).0925?.05$1.20(1.0925)1;P4 = $51.2301
2?$1.44(1.0925)?$1.728(1.0925)3?$2.0736(1.0925)4?$51.2301(1.0925)4; P0 = $41.05
82.
P4?P0?$2.50.15$3.00(1.15)$1.25.07$1.00(1.07)11; P4 = $16.6667
?$5.00(1.15)2?$7.50(1.15)3?$10(1.15)4?$16.6667(1.15)4; P0 = $26.57
83.
P3?P0?; P3 = $17.85714
?$2.50(1.07)12?$5.00(1.07)3?$17.85714(1.07)3; P0 = $21.78
84. 85. 86. 87. 88.
P0?$2.00(1.16)1P4?$.75(1?.035).12?.035; P4 = $9.13235 P0?$.25(1.12)1?$.40(1.12)2?$.60(1.12)3?$.75(1.12)4?$9.13235(1.12)4;
P0= $7.25
P4?$1.25?(1?.02).08?.021; P4 = $21.25 P0?$1.14(1.08)1?$1.18(1.08)2?$1.22(1.08)3?$1.25(1.08)4?$21.25(1.08)4; P0
= $19.57
P0?$1.20(1.07)1?$1.20(1.07)2?$1.20(1.07)3; P0= $3.15
P3?$1.00.14; P3 = $7.142857; P0?$1.50(1.16)2$.30(1.14)$.50(1.16)42?$.30(1.14)3?$7.143(1.14)3; P0 = $5.25
??$1.00(1.16)3?; P0 = $3.76
89. 90. 91. 92. 93.
Dividends for the next three years are $.56, $1.12, and $2.24.
P3?$1.50.115; P3 = $13.04348; P0?$.56(1.115)1?$1.12(1.115)2?$2.24(1.115)3?$13.04348(1.115)3
P0 = $12.43
P5?$1.40.06; P5 = $23.333 P0?$.30(1.06)1?$.50(1.06)2?$.75(1.06)3?$1.00(1.06)4?$1.20(1.06)5?$23.333(1.06)5
P0 = $20.48
P0?$0(1.08)1?$2.00(1.08)2?$0(1.08)3?$2.00(1.08)4?$50.00(1.08)5
P0 = $37.21
P0?$1.20?(1?.10).14?(?.10); P0 = $4.50
$1.80?.90(1.13)1P3?.70.13; P3 = $5.3846 P0??$1.80?(.90)(1.13)22?$1.80?(.90)(1.13)33?$5.384615(1.13)3; P0 =
$7.22
94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108.
P2?1.00.09; P2 = $11.1111 P0?$1.40?.95(1.09)1?$1.40?(.95)(1.09)22?$11.1111(1.09)2
P0 = $11.64
P = $2.00 ? .09 = $22.22 R = $1.70 ? $20.24 = 8.40% D = .0658 ? $45.60 = $3.00 P0 = $4.50 ? .12 = $37.50
Value of stock = D0(1+g)/(r-g) = $2.25(1+0.05)/(0.11-0.05) = $39.375 $1.36/.125 = $10.88
g = (D1-D0)/D0 = ($1.03-$1.00)/$1.00 = 0.03 (g=3%) Value of stock = D1/(r-g) = $1.03/(0.05-0.03) = $51.50
Value of stock = [($0.75/1.1) + ($0.84/(1.1)2) + ($0.94/(1.1)3) + ($1.05/(1.1)4) + (($1.13/.02)/(1.1)-4) = $41.39
Div(8) = $0.4*(1+.07)6 (1.04)2 = $0.65
R = Div/P0 + g = (.381(1.056))/11.625)+.056 = (.40/11.625)+.056 = .0346 + .056 = .0906 = 9% Years 1-5: ($0.50(1.2)t/(1.12)t + (1.28/.09)/(1.12)5 = $11.17
Price = $1.00(1.20)/1.12 + $1.20(1.100)/1.2544 + [$1.32(1.05)/(.12-.05)]/1.2544 = $17.90 Price = $1.00(1.25)/1.12 + $1.25(1.25)/1.2544 + [$1.5625(1.05)/(.12-.05)]/1.2544 = $21.04 Value of stock = D1/(1+r) + (D2+P2)/(1+r)2 = $10/(1+0.09) + ($11+$120)/(1+0.09) 2 = $119.43