SET 3 PRACTICE QUESTIONS Chapters 10-15: Common Stocks (Valuation and Management), Efficient Markets, Market/Economy, Industry, Company Analysis
CHAPTER 10:
1. A stock’s intrinsic value is
a. The estimated present value of the future stream of cash flows for the stock
b. The same as its market price
c. The sum of all dividends expected to be paid from now to infinity
d. Based on the accounting value of the assets
2. The basic premise of the DDM is that
a. the present value of all future dividends, properly discounted, is the intrinsic value of the stock
b. the present value of all future earnings, properly discounted, is the intrinsic value of the stock
c. the price of a stock is the sum of all dividends to be paid from now to infinity
d. investors can accurately access the future levels of dividends, and therefore can
determine what a stock is worth
3. Which of the following statements is CORRECT concerning the DDM?
a. earnings are the foundation of valuation for common stocks
b. the DDM states that the value of a stock is the discounted value of all future dividends
c. the DDM is operationalized by estimating the expected future earnings to be paid by a company, estimating the required rate of return, and discounting
d. earnings are the only cash flow stream to be received directly by investors
4. Choose the INCORRECT statement concerning the DDM:
a. It is based on the position that the price of a stock is the discounted value of all future dividends
b. Not all of its three growth rate cases involve a present value process
c. The no growth rate case is the least likely case to be encountered
d. The multiple growth rate case involves at least two different growth rates
5. Using the constant growth version of the DDM to determine the intrinsic value of a stock
a. the formula calls for the dividend to be paid this period
b. the required rate of return is expected to be larger than the growth rate in dividends
c. there is no present value process involved in the simple equation used in this case
d. the answer obtained from this equation is the definitive value for the stock for all investors
6. Which of the following statements is INCORRECT about dividends?
a. dividends are the foundation of valuation for common stocks
b. the DDM states that the value of a stock is the discounted value of all future earnings
c. the DDM is operationalized by estimating the expected future dividends to be paid by a company and estimating the required rate of return
d. dividends are the only cash flow stream to be received directly by investors
7. Sardi Company currently earns $3.00 per share and currently pays $1.20 per share in dividends. It is expected to have a constant growth rate of 7% per year. The required rate of return is 14%. The stock price is
a. $42.86
b. $18.34
c. $17.14
d. $40.05
8. Johnson stock is currently selling for $40. The expected dividend is $2. This is a constant growth firm. If investors require a return of 15% on this stock, what do they think the growth rate will be?
a. 6%
b. 7%
c. 8%
d. 11%
e. none of the above
9. Calculate the estimated price of the following stock. Required rate of return:15%; Expected dividend next year:$20
Expected constant growth rate of dividends:10%
a. 4
b. 400
c. 440
d. none of the above
10. BLC Industries is expected to pay a dividend of $1.50, and the dividend is expected to grow at a constant rate of 7%. This stock is 15% less risky than the market as a whole. The risk-free rate is 6%, and the equity risk premium for the market is 8%. The estimated price of the stock is
a. $18.75
b. $21.43
c. $27.76
d. $25.86
11. Your required rate of return is 15%. Z Corp. is currently selling for $40 and the most recent dividend paid was $2.55. The expected constant growth rate is 8%. What is the maximum you should pay for this stock?
a. $39.29
b. $40
c. $36.43
d. none of the above
12. Percy Pondscum & Company currently earns $3.00 per share and currently pays $1.20 per share in dividends. It is expected to have a constant growth rate of 7% per year. The risk free rate of return is 6%, the market risk premium is 8%, and the beta for this company is 1.0. The stock price is
a. $42.86
b. $18.34
c. $17.14
d. $40.05
e. none of the above
13. Xila expects to earn $4.00 per share next year, with an expected payout of 30%. Investors expect the dividend to grow at a constant rate of 8% for the foreseeable future. The risk-free rate is 5%, and the beta that is 10% more volatile than the market as a whole, and the expected return on the market is 14%. What is the estimated price of the stock?
a. $12.12
b. $50
c. $13.33
d. none of the above
14. Johnsey Industries' current dividend is $2. The average growth rate for the past many years has been steady at 8%, but the consensus of analysts is that the expected growth rate is 6% . k = 16%. The intrinsic value of this stock is:
a. $20
b. $18.80
c. $9.09
d. $21.20
15. Jack buys Wealth Enterprises for $40. He expects the firm's earnings and dividends to grow at an annual rate of 7%. The firm expects to pay a dividend of $2.00 next year. The market risk premium is 8%. Jack's expected rate of return is
a. 10%
b. 12%
c. 12.35%
d. 15%
16. Walter Company currently earns $3.00 per share and pays $1.00 in dividends. The dividend is expected to double in 9 years and also to grow at that rate beyond that time. The required rate of return is 15%. The estimated stock price is
a. $15.42
b. $6.66
c. $14.29
d. none of the above
17. Your required rate of return is 15.1%. Davis Drives is currently selling for $38 per share and is expected to pay a dividend of $3 next period. The expected constant growth rate is 7%. Which of the following statements is true in making a stock decision?
a. you can justify buying this stock because: expected return > the required return
b. you cannot justify buying this stock because: the required return > the expected return
c. you cannot justify buying this stock because: the required return < the expected return
d. you can justify buying this stock because: the required return > than the expected return
18. Investor A and investor B both have required rates of return of 12%. They are considering the purchase of XTRA stock, which each views as a constant growth case. Both have estimated the dividend for the next period at $1.00, and both agree that the expected growth rate in dividends will be 6% a year. However, investor A plans to buy the stock and hold it for 10 years, while investor B plans to buy the stock and hold it for ONLY 1 year. Which of the following statements is CORRECT about stock valuation?
a. Investor A should be willing to pay more for this stock than B.
b. Investor B should be willing to pay more for this stock than A.
c. Both investors should be willing to pay the same price for the stock.
d. None of these.
19. Using the constant growth model, an increase in the required rate of return from 15 to 16%, combined with an increase in the growth rate from 7 to 8%, would cause the price of a constant growth stock, to: (assume the next dividend is $2.00)
a. increase in price
b. decrease in price
c. stay the same
d. not enough information to answer the question
20. Low Labs. last dividend was $1.50. Its current equilibrium stock price is $15.75, and its expected growth rate is a constant 5 percent. If the stockholders' required rate of return is 15 percent, what is the expected dividend yield and expected capital gains yield for the coming year?
a. 0%; 15%
b. 5%; 10%
c. 10%; 5%
d. 15%; 0%
21. The Smith Reclamation Company has been hit hard due to increased competition. The company’s analysts predict that earnings (and dividends) will decline at a rate of 5 percent annually from now on. k = 14% and D0 = $2.00. What will be the estimated price of the company’s stock four years from now (this will be the price at the beginning of year 5)? Round all calculations to two places.
a. $27.17
b. $11.11
c. $28.50
d. $10.18
e. $8.16
22. A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.00, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, what is the estimated price of this stock? Round calculations to two places.
a. $67.81
b. $22.49
c. $58.15
d. $31.00
e. none of the above
23. Find the estimated price of Robot Communications if the expected growth rate in dividends is 14% for the next three years, after which the dividend is expected to slow down and grow at a rate of 6%. The current dividend is $2.00 per share, and the required rate of return is 18%. Round calculations to two decimal places.
a. $31.77
b. $26.17
c. $21.52
d. $15.94
24. ABC Company has been growing at a 10% rate, and it just paid a dividend of D0 = $3.00. Due to a new product, ABC expects to achieve a dramatic increase in its short-run growth rate, to 20% annually for the next 2 years, after which growth is expected to return to the long-run constant rate of 10 percent. The company’s beta is 2.0, the required return on an average stock is 11 percent, and the risk-free rate is 7 percent. Calculate the expected dividend yield, D1/P0. Round calculations to two places.
a. 3.93%
b. 4.58%
c. 10.00%
d. 7.54%
25. Which of the following statements about stock valuation is INCORRECT?
a. dividends are the foundation of valuation for common stocks
b. the DDM states that the value of a stock is the discounted value of all future earnings
c. the DDM is based on a present value process
d. dividends are the only cash flow stream to be received directly by investors
26. Common stocks are difficult to value because
a. The price change component of total return, unlike the income component, cannot be known with certainty
b. The DDM equation involves an infinity sign
c. Inflation affects stock returns more than bond returns
d. Both the cash flows and the required rate of return must be estimated
27. ABC corp. expects to earn $4.00 per share next year, and pay $3.00 per share in dividends. Expected growth rate in dividends is 6%, required rate of return is 16%. The P/E ratio is
a. 6
b. 10
c. 7.5
d. 5
28. X Corp. retains 70% of its earnings in the business. The long-run earnings growth is expected to be 10%. The risk-free rate is 8%, the expected return on the market is 12%, the beta is 2.0, and the most recent dividend was $1.50. What are the most likely market price and P/E for this stock today?
a. $27.50, 5x
b. $33, 6x
c. $25, 5x
d. $22.50, 4.5x
e. $45, 4.5x
29. Price to book value is
a. the ratio of book value to stockholder's equity
b. most useful when book value and market value differs sharply
c. sometimes used to value companies
d. useful because it avoids any accounting problems
CHAPTER 11:
30. Which statement about the required rate of return is INCORRECT?
a. There are many required rates of return.
b. The average required rate of return on bonds is different from that generally required in common stocks.
c. Investor optimism leads to an increase in the required return for a particular stock.
d. The level of the required rates of return changes over time.
31. The INCORRECT statement involving the required rate of return for a stock is:
a. it equals the risk-free rate plus the market risk premium
b. ex ante, it must slope upward
c. the overall level of required rates of return changes as the risk premiums change
d. it is the minimum expected rate of return needed to induce an investor to purchase a security
32. Select the INCORRECT statement concerning a buy-and-hold strategy
a. it is applicable to the investor's portfolio, whatever its composition
b. it emphasizes the avoidance of transaction costs
c. investors must still perform several functions while the strategy is in existence
d. it avoids the decision of having to make an initial selection
33. Sector rotation is
a. one form of passive investing
b. an active strategy similar to stock selection
c. an attempt to earn excess returns by varying the percentage of portfolio assets in equity securities
d. not dependent on an accurate assessment of current economic conditions
34. With regard to security analysts,
a. there are more sell side analysts than buy side analysts
b. security analyst have become more and more respected over the years
c. analysts’ estimates have become more and more accurate
d. investors can use analysts reports and information intelligently
35. Fundamental analysts assume that the market price and intrinsic value of a stock
a. are always identical
b. can differ from time to time
c. bear no relationship to each other