Chapter 05

The Value of Common Stocks

MultipleChoiceQuestions:

1. CKCompanystockholdersexpecttoreceiveayearenddividendof$5per
shareandthenbesoldfor$115dollarspershare.Iftherequiredrateofreturn
forthestockis20%,whatisthecurrentvalueofthestock?
A.$100
b.$122
c.$132
d.$110

P=(115+5)/1.2=100

2. 16.(p.100)DeluxeCompanyexpectstopayadividendof$2pershareattheend
ofyear1,$3pershareattheendofyear2andthenbesoldfor$32pershare.
Iftherequiredrateonthestockis15%,whatisthecurrentvalueofthestock?
A.$28.20
b.$32.17
c.$32.00
d.Noneofthegivenanswers

P0=(2/1.15)+[(3+32)/(1.15^2)]=$28.20

3. CasinoInc.isexpectedtopayadividendof$3pershareattheendofyear1
(D1)andthesedividendsareexpectedtogrowataconstantrateof6%peryear
forever.Iftherequiredrateofreturnonthestockis18%,whatiscurrentvalue
ofthestocktoday?
A.$25
b.$50
c.$100
d.$54

P0=Div1/(rg)=(3/(0.180.06))=25
 4. WillCo.isexpectedtopayadividendof$2pershareattheendofyear1(D1)
andthedividendsareexpectedtogrowataconstantrateof4%forever.Ifthe
currentpriceofthestockis$20persharecalculatetheexpectedreturnorthe
costofequitycapitalforthefirm:
a.10%
b.4%
C.14%
d.Noneoftheabove
r=[(D1/P0)+g]=(2/20)+0.04=14%

5. GeneralElectric(GE)hasabout10.3billionsharesoutstandingandthestock
priceis$37.10.TheP/Eratioisabout18.3.Calculatethemarketcapitalization
forGE.(Approximately)
a.$679billion
b.$188billion
C.$382billion
d.Noneoftheabove

Marketcapitalization=(10.3)(37.10)=$382.13billion

6. A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of
return is rs = 12.5%, and the expected constant growth rate is g = 8.5%. What is the
current stock price?

A. $17.82
B. $18.28
C. $18.75
D. $19.22
E. $19.70

Constant growth valuation: Answer: c

D1 $0.75
rs 12.5%
g 8.5%
P0 = D1/(rs g) $18.75

7. A stock just paid a dividend of D0 = $1.75. The required rate of return is rs = 12.0%, and
the constant growth rate is g = 4.0%. What is the current stock price?

A. $20.56
B. $21.09
C. $21.63
 D. $22.18
E. $22.75

Constant growth valuation Answer: e

D0 $1.75
rs 12.0%
g 4.0%
D1 = D0(1 + g) = $1.82 Intermediate step used to find answer
P0 = D1/(rs g) $22.75

8. Ashareofcommonstockhasjustpaidadividendof$2.00.Iftheexpected
longrungrowthrateforthisstockis5.0%,andifinvestors'requiredrateof
returnis10.5%,whatisthestockprice?

A. $35.39

B. $36.30

C. $37.23

D. $38.18

E. $39.14

Constant growth valuation Answer: d

Last dividend (D0) $2.00

Long-run growth rate 5.0%
Required return 10.5%
D1 = D0(1 + g) = $2.10 Intermediate step used to find answer
P0 = D1/(rs g) $38.18

9. Ewert Enterprises' stock currently sells for $30.50 per share. The stocks dividend is
projected to increase at a constant rate of 4.50% per year. The required rate of return on
the stock, rs, is 10.00%. What is Ewert's expected price 3 years from today?
a. $31.61
b. $32.43
c. $33.26
d. $34.11
e. $34.81

Future price of a constant growth stock: Answer: e EASY

Stock price $30.50

Growth rate 4.50%
Years in the future 3
P3 = P0(1 + g)3 = $34.81

10. E. M. Roussakis Inc.'s stock currently sells for $45 per share. The stocks dividend is projected
constant rate of 3.75% per year. The required rate of return on the stock, rs, is 15.50%. What is R
expected price 5 years from now?

A. $48.88
B. $50.14
C. $51.42
D. $52.74
E . $54.09

Future price of a constant growth stock Answer: e EASY

Growth rate 3.75%

Years in the future 5
Stock price $45.00
P5 = P0(1 + g)5 = $54.09

11.The Isberg Company just paid a dividend of $0.80 per share, and that dividend is expected to
grow at a constant rate of 6.00% per year in the future. The company's beta is 1.25, the
market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current
stock price?

A. $19.95
B. $20.45
C. $20.96
D. $21.49
 E. $22.02

Constant growth valuation: CAPM Answer: a

D0 $0.80
b 1.25
rRF 4.0%
RPM 5.0%
g 6.0%
D1 = D0(1 + g) = $0.85 Intermediate step
rs = rRF + b(RPM) = 10.3% Intermediate step
P0 = D1/(rs g) $19.95

12.Schnusenberg Corporation just paid a dividend of $0.65 per share, and that dividend is
expected to grow at a constant rate of 7.00% per year in the future. The company's beta is
0.95, the required return on the market is 10.50%, and the risk-free rate is 5.00%. What is
the company's current stock price?

A. $21.57
B. $22.11
C. $22.66
D. $23.22
E. $23.80
Constant growth valuation: CAPM Answer: a

D0 $0.65
b 0.95
rRF 5.0%
rM 10.5%
g 7.0%
D1 = D0(1 + g) = $0.70 Intermediate step
rs = rRF + b(rM RRF) = 10.2% Intermediate step
P0 = D1/(rs g) $21.57

13.Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per
share. Goode's dividend is expected to grow at a constant rate of 7.00% per year. What
was Goode's last dividend, D0?

A. $0.95
B. $1.05
C. $1.16
D. $1.27
E. $1.40
Constant growth dividend Answer: b

Stock price $25.00

Required return 11.50%
Growth rate 7.00%
P0 = D1/(rs g), so D1 = P0(rs g) =$1.13 Intermediate step
Last dividend = D1/(1 + g) $1.05