Chapter 18

3. Award: 10.00 points Problems? Adjust credit for all students. A firm pays a current dividend of $1.00, which is expected to grow at a rate of 5% indefinitely. If current value of the firm’s shares is $35.00, what is the required return based on the constant-growth dividend discount model (DDM)? Note: Round your answer to the nearest whole percent. Required return 8 % Explanation: The Gordon DDM uses the dividend for period ( t + 1) which would be $1.00 × (1 + 0.05): $35 = $1.050 ÷ ( k − 0.05) k = ($1.05 ÷ $35) + 0.05 = 0.08 = 8% The required return is 8.00% Worksheet Difficulty: 1 Basic Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

6. Award: 10.00 points Problems? Adjust credit for all students. MF Corporation has an ROE of 16% and a plowback ratio of 50%. The market capitalization rate is 12%. Required: a. If the coming year’s earnings are expected to be $2 per share, at what price will the stock sell? b. What price do you expect MF shares to sell for in three years? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. $ $ a. Price 25 b. Price 31.49 Explanation: a. g = ROE × b = 16% × 0.5 = 8% D 1 = EPS 1 × (1 − b ) = $2 × (1 − 0.5) = $1 P 0 = D 1 ÷ ( k − g ) = $1 ÷ (0.12 − 0.08) = $25 b. P 3 = P 0 × (1 + g ) 3 = $25.00 × (1.08) 3 = $31.49 Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

7. Award: 10.00 points Problems? Adjust credit for all students. The market consensus is that Analog Electronic Corporation has an ROE = 9% and a beta of 1.25 and plans to maintain indefinitely its traditional plowback ratio of 2/3. This year’s earnings were $3 per share. The annual dividend was just paid. The consensus estimate of the coming year’s market return is 14%, and T-bills currently offer a 6% return. Required: a. Find the price at which Analog stock should sell. b. Calculate the P/E ratio. c. Calculate the present value of growth opportunities. d. Suppose your research convinces you Analog will announce momentarily that it will immediately reduce its plowback ratio to 1/3. Find the intrinsic value of the stock.  Required B Required D  Complete this question by entering your answers in the tabs below. Calculate the present value of growth opportunities. Note: Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places. Required A Required B Required C Required D $ PVGO (9.28) Explanation: a. k = r f + β × [ E ( r m ) − r f ] = 6% + 1.25 × (14% − 6%) = 16% g = (2/3) × 9% = 6% D 1 = E 0 × (1 + g ) × (1 − b ) = $3 × (1.06) × (1/3) = $1.06 V 0 = D 1 ÷ ( k − g ) = $1.06 ÷ (0.16 − 0.06) = $10.60 Analog Electronic Corporation should sell for $10.60. b. Leading P 0 ÷ E 1 = $10.60 ÷ $3.18 = 3.33 Trailing P 0 ÷ E 0 = $10.60 ÷ $3.00 = 3.53 c. PVGO = P 0 − ( E 1 ÷ k ) = 10.60 − ($3.18 ÷ 0.16) = −$9.28 The low P/E ratios and negative PVGO are due to a poor ROE (9%) that is less than the market capitalization rate (16%). d. Now, you revise b to 1/3, g to 1/3 × 9% = 3%, and D 1 to: E 0 × (1 + g ) × (2/3) $3 × 1.03 × (2/3) = $2.06 Thus: V 0 = D 1 ÷ ( k − g ) = $2.06 ÷ (0.16 − 0.03) = $15.85 Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

9. Award: 10.00 points Problems? Adjust credit for all students. Eagle Products’ EBITDA is $300, its tax rate is 21%, depreciation is $20, capital expenditures are $60, and the planned increase in net working capital is $30. What is the free cash flow to the firm? Note: Round your answer to 2 decimal place. $ FCFF 151.20 Explanation: Free cash flow to the firm is $151.20: FCFF = ( EBITDA − Depreciation ) × (1 − t ) + Depreciation − Capital Expenditures − Δ NWC = ($300 − $20) × (0.79) + $20 − $60 − $30 = $151.2 Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

12. Award: 10.00 points Problems? Adjust credit for all students. The stock of Nogro Corporation is currently selling for $10 per share. Earnings per share in the coming year are expected to be $2. The company has a policy of paying out 50% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 20% rate of return per year. This situation is expected to continue indefinitely. Required: a. Assuming the current market price of the stock reflects its intrinsic value as computed using the constant-growth DDM, what rate of return do Nogro’s investors require? b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? c. If Nogro were to cut its dividend payout ratio to 25%, what would happen to its stock price? Note: Round your answer to 2 decimal places. d. What would happen to its stock price if Nogro eliminated the dividend? Note: Round your answer to 2 decimals places. $ $ $ a. Rate of return 20 % b. PVGO 0 c. Stock price 10.00 d. Stock price 10.00 Explanation: a. The required return on Nogro Corporation is 20.00%. k = ( D 1 ÷ P 0 ) + g = ( EPS 1 × (1 − b )) ÷ P 0 + ROE × b k = $2.00 × (1 − 0.50) ÷ $10.00 + 0.20 × 0.50 = 0.20 b. The PVGO of Nogro Corporation is $0.00, since ROE = k: P 0 = ( E 1 ÷ k ) + PVGO $10 = ($2.00 ÷ 0.20) + PVGO PVGO = $0.00 c. The price should remain the same at $10.00 P 0 = D 1 ÷ ( k − g ) = ($2.00 × (1 − 0.75)) ÷ (0.200 − 0.20 × 0.75) = $10.00 d. The price should remain the same, as long as investors realistically believe that dividends will be paid out in the future, when ROE = k, the dividend payout rate is irrelevant. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

14. Award: 10.00 points Problems? Adjust credit for all students. The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next five years. Its latest EPS was $10, all of which was reinvested in the company. The firm’s expected ROE for the next five years is 20% per year, and during this time it is expected to continue to reinvest all of its earnings. Starting in year 6, the firm’s ROE on new investments is expected to fall to 15%, and the company is expected to start paying out 40% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 15% per year. Required: a. What is your estimate of DEQS’s intrinsic value per share? b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? c. What do you expect to happen to price in the following year? d. What is your estimate of DEQS’s intrinsic value per share if you expected DEQS to pay out only 20% of earnings starting in year 6?  Required A Required C  Complete this question by entering your answers in the tabs below. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? Note: Do not round intermediate calculations. Round your dollar value to 2 decimal places. Required A Required B Required C Required D $ Price will rise by 15 % per year until year 6. Because there is no dividend , the entire return must be in captial gains. Price in one year 103.38 Explanation: Time: 0 1 5 6 E t $ 10.000 $ 12.000 $ 24.883 $ 27.123 D t $ 0.000 $ 0.000 $ 0.000 $ 10.849 b 1.00 1.00 1.00 0.60 g 20.0% 20.0% 20.0% 9.0% The year-6 earnings estimate is based on growth rate of 0.15 × (1 − 0.40) = 0.09. a. V 5 = D 6 ÷ ( k − g ) = $10.85 ÷ (0.15 − 0.09) = $180.82 V 0 = V 5 ÷ (1 + k ) 5 = $180.82 ÷ 1.15 5 = $89.90 b. The price should rise by 15% per year until year 6: because there is no dividend, the entire return must be in capital gains. The price in one year should be $103.38. c. The price should rise by 15% per year until year 6: because there is no dividend, the entire return must be in capital gains. The price in two years should be $118.89. d. Time: 0 1 5 6 E t $ 10.000 $ 12.000 $ 24.883 $ 27.869 D t $ 0.000 $ 0.000 $ 0.000 $ 5.574 b 1.00 1.00 1.00 0.80 g 20.0% 20.0% 20.0% 12.0% The year-6 earnings estimate is based on growth rate of 0.15 × (1 − 0.20) = 0.12. V 5 = D 6 ÷ ( k − g) = $5.57 ÷ (0.15 − 0.12) = $185.79 V 0 = V 5 ÷ (1 + k ) 5 = ($185.79 ÷ 1.15 5 ) = $92.37 Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

15. Award: 10.00 points Problems? Adjust credit for all students. Calculate the intrinsic value of Toyota in each of the following scenarios by using the three-stage growth model of Spreadsheet 18.1 . Treat each scenario independently. Required: a. The terminal growth rate will be 4.5%. Note: Round your answer to 2 decimal places. b. Toyota’s beta is 0.9. Note: Round your answer to 2 decimal places. c. The market risk premium is 7.5%. Note: Round your answer to 2 decimal places. $ $ $ a. Intrinsic value 141.13 b. Intrinsic value 126.33 c. Intrinsic value 178.49 Explanation: a. Using the Excel Spreadsheet 18.1, we find that the intrinsic value is $141.13 when the terminal growth rate is 4.5% b. Using the Excel Spreadsheet 18.1, we find that the intrinsic value is $126.33 when the actual beta is 0.9. c. Using the Excel Spreadsheet 18.1, we find that the intrinsic value is $178.49 when market risk premium is 7.5%. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

16. Award: 10.00 points Problems? Adjust credit for all students. Calculate the intrinsic value of Toyota shares using the free cash flow model of Spreadsheet 18.2 . Treat each scenario independently. Required: a. Toyota’s P/E ratio starting in 2025 (cell G3) will be 11.5. b. Toyota’s unlevered beta (cell B22) is 0.65. c. The market risk premium (cell B27) is 7.5%.  Required A Required B  Complete this question by entering your answers in the tabs below. Toyota’s P/E ratio starting in 2025 (cell G3) will be 11.5. Note: Round your intrinsic values to the nearest whole number and per share values to 2 decimal places. Required A Required B Required C $ $ $ $ Intrinsic Value Per Share PV(FCFF) 300,181 139.04 PV(FCFE) 173,486 126.17 Explanation: No further explanation details are available for this problem. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

16. Award: 10.00 points Problems? Adjust credit for all students. Calculate the intrinsic value of Toyota shares using the free cash flow model of Spreadsheet 18.2 . Treat each scenario independently. Required: a. Toyota’s P/E ratio starting in 2025 (cell G3) will be 11.5. b. Toyota’s unlevered beta (cell B22) is 0.65. c. The market risk premium (cell B27) is 7.5%.  Required A Required C  Complete this question by entering your answers in the tabs below. Toyota’s unlevered beta (cell B22) is 0.65. Note: Round your intrinsic values to the nearest whole number and per share values to 2 decimal places. Required A Required B Required C $ $ $ $ Intrinsic Value Per Share PV(FCFF) 247,092 100.43 PV(FCFE) 153,948 111.96 Explanation: No further explanation details are available for this problem. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

16. Award: 10.00 points Problems? Adjust credit for all students. Calculate the intrinsic value of Toyota shares using the free cash flow model of Spreadsheet 18.2 . Treat each scenario independently. Required: a. Toyota’s P/E ratio starting in 2025 (cell G3) will be 11.5. b. Toyota’s unlevered beta (cell B22) is 0.65. c. The market risk premium (cell B27) is 7.5%.  Required B Required C  Complete this question by entering your answers in the tabs below. The market risk premium (cell B27) is 7.5%. Note: Round your intrinsic values to the nearest whole number and per share values to 2 decimal places. Required A Required B Required C $ $ $ $ Intrinsic Value Per Share PV(FCFF) 361,054 183.31 PV(FCFE) 200,490 145.81 Explanation: No further explanation details are available for this problem. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

17. Award: 10.00 points Problems? Adjust credit for all students. The Duo Growth Company just paid a dividend of $1 per share. The dividend is expected to grow at a rate of 25% per year for the next three years and then to level off to 5% per year forever. You think the appropriate market capitalization rate is 20% per year. Required: a. What is your estimate of the intrinsic value of a share of the stock? Note: Use intermediate calculations rounded to 4 decimal places. Round your answer to 2 decimal places. b. If the market price of a share is equal to this intrinsic value, what is the expected dividend yield? Note: Use intermediate values rounded to 2 decimal places. Round your answer to 1 decimal place. c. What do you expect its price to be one year from now? Note: Use intermediate values rounded to 4 decimal places. Round your answer to 2 decimal places. d-1. What is the implied capital gain? Note: Use intermediate values rounded to 2 decimal places. Round your answer to 1 decimal place. d-2. Is the implied capital gain consistent with your estimate of the dividend yield and the market capitalization rate? $ $ a. Intrinsic value per share 11.17 b. Expected dividend yield 11.2 % c. Expected price 12.15 d-1. Implied Capital Gain 8.8 % d-2. Is this consistent with the DDM? Yes Explanation: a. We begin by forecasting per share dividends in years 1-3 based on the current dividend ( D 0 = $1) and the initial growth rate of 25%. Time Dividend % increase vs previous year PV(Dividend) 0 1 1 1.25 25% 1.25 ÷ (1.20) = 1.0417 2 1.5625 25% 1.5625 ÷ (1.20) 2 = 1.0851 3 1.9531 25% 1.9531 ÷ (1.20) 3 = 1.1303 By time 3, dividend growth is expected to settle down to a sustainable rate of g = 0.05. Therefore, the price at which the stock can be sold at time 3 can be estimated from the constant-growth dividend discount model: P 3 = D 4 ÷ ( k − g ) = (D 3 (1 + g )) ÷ ( k − g ) = ($1.9531(1.05)) ÷ (0.20 − 0.05) = $13.6717 The present value of the sales price is 13.6717 ÷ (1.20) 3 = 7.9119 Therefore the price of the stock today should be: P 0 = PV(Dividends) + PV(Sales price) = 1.0417 + 1.0851 + 1.1303 + 7.9119 = 11.17 b. Expected dividend yield = D 1 ÷ P 0 = $1.25 ÷ $11.17 = 0.112 = 11.2% c. The expected price one year from now is the PV at that time of P 2 and D 2: P 1 = ( D 2 ÷ (1 + k)) + ((D 3 + P 3 ) ÷ (1 + k) 2 ) = ($1.5625 ÷ 1.20) + ($1.9531 + 13.6717) ÷ 1.20 2 = $12.15 d. The implied capital gain is: ( P 1 − P 0 ) ÷ P 0 = ($12.15 − $11.17) ÷ $11.17 = 0.088 = 8.8% The sum of the expected capital gains yield and the expected dividend yield is 8.8% + 11.2% = 20%, which equals the market capitalization rate. This is consistent with the DDM. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

18. Award: 10.00 points Problems? Adjust credit for all students. The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next four years. Its latest EPS was $5, all of which was reinvested in the company. The firm’s expected ROE for the next four years is 20% per year, during which time it is expected to continue to reinvest all of its earnings. Starting in year 5, the firm’s ROE on new investments is expected to fall to 15% per year. GG’s market capitalization rate is 15% per year. Required: a. What is your estimate of GG’s intrinsic value per share? b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year?  Required A Required B  Complete this question by entering your answers in the tabs below. What is your estimate of GG’s intrinsic value per share? Note: Round your answer to 2 decimal places. Required A Required B $ GG’s intrinsic value 45.45 Explanation: a. We are not given a plowback rate for years after the fourth year. But in this case, we don’t need one. This is because we are told that the ROE falls to a level exactly equal to the market capitalization rate. When ROE = k, the present value of growth opportunities is exactly zero, and the value of the firm is independent of plowback. (Recall the discussion of Cash Cow on page 580 of the text.) Therefore, we might as well assume that all earnings are paid out as dividends starting with the dividend paid at the end of year 5. This is what we do in the following table. Because ROE in the fifth year will be 15% (and the firm will not start paying dividends until the end of year 5), earnings in year 5 will be 15% higher than earnings in year 4, so E5 = $10.368 × 1.15 = $11.9232. Since all of year-5 earnings are paid out as dividends, D5 = $11.9232. Time: 0 1 4 5 E t $ 5.0000 $ 6.0000 $ 10.368 $ 11.9232 D t $ 0.000 $ 0.000 $ 0.000 $ 11.9232 Moreover, since we are assuming a payout ratio of 100% (so plowback = 0) starting in year 5, future growth (after year 5) will be zero, and P 4 = D 5 ÷ k = $11.9232 ÷ 0.15 = $79.49 Therefore, V 0 = P 4 ÷ (1 + k ) 4 = $79.49 ÷ 1.15 4 = $45.45 b. Price should increase at a rate of 15% over the next year ($45.45), so that the HPR will equal k . Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

18. Award: 10.00 points Problems? Adjust credit for all students. The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next four years. Its latest EPS was $5, all of which was reinvested in the company. The firm’s expected ROE for the next four years is 20% per year, during which time it is expected to continue to reinvest all of its earnings. Starting in year 5, the firm’s ROE on new investments is expected to fall to 15% per year. GG’s market capitalization rate is 15% per year. Required: a. What is your estimate of GG’s intrinsic value per share? b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year?  Required A Required B  Complete this question by entering your answers in the tabs below. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? Required A Required B Price should increase at a rate of 15 % over the next year. Explanation: a. We are not given a plowback rate for years after the fourth year. But in this case, we don’t need one. This is because we are told that the ROE falls to a level exactly equal to the market capitalization rate. When ROE = k, the present value of growth opportunities is exactly zero, and the value of the firm is independent of plowback. (Recall the discussion of Cash Cow on page 580 of the text.) Therefore, we might as well assume that all earnings are paid out as dividends starting with the dividend paid at the end of year 5. This is what we do in the following table. Because ROE in the fifth year will be 15% (and the firm will not start paying dividends until the end of year 5), earnings in year 5 will be 15% higher than earnings in year 4, so E5 = $10.368 × 1.15 = $11.9232. Since all of year-5 earnings are paid out as dividends, D5 = $11.9232. Time: 0 1 4 5 E t $ 5.0000 $ 6.0000 $ 10.368 $ 11.9232 D t $ 0.000 $ 0.000 $ 0.000 $ 11.9232 Moreover, since we are assuming a payout ratio of 100% (so plowback = 0) starting in year 5, future growth (after year 5) will be zero, and P 4 = D 5 ÷ k = $11.9232 ÷ 0.15 = $79.49 Therefore, V 0 = P 4 ÷ (1 + k ) 4 = $79.49 ÷ 1.15 4 = $45.45 b. Price should increase at a rate of 15% over the next year ($45.45), so that the HPR will equal k . Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

19. Award: 10.00 points Problems? Adjust credit for all students. The MoMi Corporation’s cash flow from operations before interest and taxes was $2 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 20% of pretax cash flow each year. The tax rate is 21%. Depreciation was $200,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. The appropriate market capitalization rate for the unleveraged cash flow is 12% per year, and the firm currently has debt of $4 million outstanding. Use the free cash flow approach to value the firm’s equity. Note: Enter your answer in dollars not in millions. $ Value of the equity 14,330,000 Explanation: Before-tax cash flow from operations $ 2,100,000 Depreciation 210,000 Taxable Income 1,890,000 Taxes (@ 21%) 396,900 After-tax unleveraged income 1,493,100 After-tax cash flow from operations (After-tax unleveraged income + depreciation) 1,703,100 New investment (20% of cash flow from operations) 420,000 Free cash flow (After-tax cash flow from operations − new investment) $ 1,283,100 The value of the firm (i.e., debt plus equity) is: V 0 = C 1 ÷ ( k − g ) = $1,283,100 ÷ (0.12 – 0.05) = $18,330,000 Since the value of the debt is $4 million, the value of the equity is $14,330,000. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

20. Award: 10.00 points Problems? Adjust credit for all students. Chiptech, Incorporated, is an established computer chip firm with several profitable existing products as well as some promising new products in development. The company earned $1 a share last year, and just paid out a dividend of $0.50 per share. Investors believe the company plans to maintain its dividend payout ratio at 50%. ROE equals 20%. Everyone in the market expects this situation to persist indefinitely. Required: a. What is the market price of Chiptech stock? The required return for the computer chip industry is 15%, and the company has just gone ex-dividend (i.e., the next dividend will be paid a year from now, at t = 1). b. Suppose you discover that Chiptech’s competitor has developed a new chip that will eliminate Chiptech’s current technological advantage in this market. This new product, which will be ready to come to the market in two years, will force Chiptech to reduce the prices of its chips starting in year 3 to remain competitive. This will decrease ROE in the third year and beyond to 15%. Anticipating the reduced profitability of new investments that will take hold beginning in year 3, the firm plows back a lower fraction of earnings starting at the end of the second year; therefore, the plowback ratio in year 2 and beyond will fall to 0.40. What is your estimate of Chiptech’s intrinsic value per share? ( Hint: Carefully prepare a table of Chiptech’s earnings and dividends for each of the next three years. Pay close attention to the change in the payout ratio at the end of the second year.) Note: Do not round intermediate calculations. Round your answers to 2 decimal places. c. No one else in the market perceives the threat to Chiptech’s market. In fact, you are confident that no one else will become aware of the change in Chiptech’s competitive status until the competitor firm publicly announces its discovery near the end of year 2. What will be the rate of return on Chiptech stock in the coming year (i.e., between t = 0 and t = 1)? ( Hint for parts c through e: Pay attention to when the market catches on to the new situation. A table of dividends and market prices over time might help.) Note: Do not round intermediate calculations. Negative amount should be indicated by a minus sign. d. What will be the rate of return on Chiptech stock in the second year (between t = 1 and t = 2)? Note: Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 1 decimal place. e. What will be the rate of return on Chiptech stock in the third year (between t = 2 and t = 3)? Note: Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to the nearest whole percent. $ $ $ a. Market price of Chiptech stock 11 b. Estimate at time 2 8.55 b. Estimate at time 0 7.49 c. Rate of return 15 % d. Rate of return (23.3) % e. Rate of return 15 % Explanation: a. g = ROE × b = 20% × 0.5 = 10% P 0 = D 1 ÷ ( k − g ) = D 0 (1 + g ) ÷ ( k − g ) = ($0.50 × 1.10) ÷ (0.15 − 0.10) = $11 b. Time EPS Dividend Comment 0 $ 1.0000 $ 0.5000 1 1.1000 0.5500 g = 10%, plowback = 0.50 2 1.2100 0.7260 EPS has grown by 10% based on last year’s earnings plowback and ROE; this year’s b falls to 0.40 → payout = 0.60 3 $ 1.2826 $ 0.7696 EPS grows by (0.4) (15%) = 6% and payout ratio = 0.60 At time 2: P 2 = D 3 ÷ ( k − g ) = $0.7696 ÷ (0.15 − 0.06) = $8.551 At time 0: V 0 = ($0.55 ÷ 1.15) + ($0.726 + $8.551) ÷ (1.15) 2 = $7.493 c. P 0 = $11 and P 1 = P 0 (1 + g ) = $12.10 (Because the market is unaware of the changed competitive situation, it believes the stock price should grow at 10% per year, in other words, no new information is publicly available.) (($12.10 − $11) + $0.55) ÷ $11 = 0.150, or 15.00% d. P 1 = P 0 (1 + g ) = $12.10 and P 2 = $8.551 after the market becomes aware of the changed competitive situation. (($8.551 − $12.10) + $0.726) ÷ $12.10 = −0.233, or −23.33% e. P 2 = $8.551 and P 3 = $8.551 × 1.06 = $9.064 (The new growth rate is 6%.) (($9.064 − $8.551) + $0.7696) ÷ $8.551 = 0.150, or 15.00% Moral: In normal periods when there is no special information, the stock return = k = 15%. When special information arrives, all the abnormal return accrues in that period , as one would expect in an efficient market. Worksheet Difficulty: 3 Challenge Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Problems - Algorithmic & Static References

21. Award: 10.00 points Problems? Adjust credit for all students. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.86 in dividends and $37.50 from the sale of the stock at the end of the year. What is the maximum price you will pay for the stock today if you want to earn a return of 11%? Note: Round your answer to 2 decimal places. $ Maximum price 35.46 Explanation: The value of the stock is the present value of its expected cash flows. Since both amounts are expected to be received in one year, add them together and discount them by the required rate of return for one period. The result is V 0 = ( D 1 + P 1 ) ÷ (1 + k ) = ($1.86 + 37.50 ) ÷ (1.11) 1 = $35.46 . Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

22. Award: 10.00 points Problems? Adjust credit for all students. Moderate Growth Company paid a dividend last year of $2.70. The expected ROE for next year is 13%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 51%, what should the dividend in the coming year be? Note: Round your answer to 3 decimal places. $ Dividend 2.879 Explanation: The growth rate is the product of the plowback ratio and the ROE. Inserting the values we have into the equation g = ROE( b ) gives us g = (0.13)(0.51) = 6.63%. The dividend should grow at a rate of 6.63%, so D 1 = D 0 (1 + g ) = $2.70(1.0663) = $2.879. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

23. Award: 10.00 points Problems? Adjust credit for all students. Saks is expected to pay a dividend in year 1 of $2.25, a dividend in year 2 of $2.57, and a dividend in year 3 of $3.14. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. What should the stock price be worth? Note: Do not round intermediate calculations. Round your answer to 4 decimal places. $ Stock price 89.0627 Explanation: Since growth is constant after year 3, the constant growth model can be used to find the value of the stock at year 3 ( P 3 ) from the relationship P 3 = D 4 ÷ ( k – g ). Then we can find the value of the stock as the sum of the discounted dividends and the discounted P 3 . D 4 = D 3 (1 + g ) = $3.14(1.08) = $3.3912. So P 3 = $3.3912 ÷ (0.11 − 0.08) = $113.04. The relevant cash flows and their present values are shown in the table below. The value of the stock is $89.0627. Time Cash Flow PV of CF @ 11% 1 $ 2.25 $2.25 ÷ (1.11) 1 = $2.0270 2 $ 2.57 $2.57 ÷ (1.11) 2 = $2.0859 3 $3.14 + 113.04 = $116.18 $116.18 ÷ (1.11) 3 = $84.9498 Sum = V 0 $89.0627 Worksheet Difficulty: 3 Challenge Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

24. Award: 10.00 points Problems? Adjust credit for all students. Declining Products Corporation produces goods that are very mature in their product life cycles. Declining Products is expected to pay a dividend in year 1 of $1.27, a dividend of $1.17 in year 2, and a dividend of $1.12 in year 3. After year 3, dividends are expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. What should the stock be worth? Note: Round your answer to 4 decimal places. $ Stock price 11.7812 Explanation: Since growth is constant after year 3, the constant growth model can be used to find the value of the stock at year 3 ( P 3 ) from the relationship P 3 = D 4 ÷ (k – g ). Then we can find the value of the stock as the sum of the discounted dividends and the discounted P 3 . D 4 = D 3 (1 + g ) = $1.12(0.98) = $1.0976. So P 3 = $1.0976 ÷ (0.08 + (0.02)) = $10.976. The relevant cash flows and their present values are shown in the table below. The value of the stock today is $11.7812. Note that the negative growth rate leads to a stock value that is lower than it would have been with a zero or a positive growth rate. Time Cash Flow PV of CF @ 8% 1 $ 1.27 $1.27 ÷ (1.08) 1 = $1.1759 2 $ 1.17 $1.17 ÷ (1.08) 2 = $1.0031 3 $1.12 + 10.98 = $12.10 $12.10 ÷ (1.08) 3 = $9.6022 Sum = V 0 $11.7812 Worksheet Difficulty: 3 Challenge Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

25. Award: 10.00 points Problems? Adjust credit for all students. Plastic Pretzels stock recently paid a dividend of $1.27 per share. The dividend growth rate is expected to be 6.00% indefinitely. Stockholders require a return of 11.60% on this stock. Required: a. What is the current intrinsic value of Plastic Pretzels stock? Note: Round your answer to 2 decimal places. $ Intrinsic value 24.04 b. What would you expect the price of this stock to be in one year if its current price is equal to its intrinsic value? Note: Round your answer to 4 decimal places. $ Expected price 25.4816 c. If you were to buy Plastic Pretzels stock now and sell it after receiving the dividend one year from now, what would be your holding period return (HPR)?opportunities. Note: Round your answer to 2 decimal places. HPR 11.60 % d. If you are able to purchase the stock for $23.10 instead of its intrinsic value today, what would be the holding period return? Note: Round your answer to 2 decimal places. Indicate negative values with a minus sign. HPR 16.14 % Explanation: a. The current intrinsic value of Plastic Pretzels stock equals the next expected dividend divided by the difference between the required rate of return and the expected growth rate: P 0 = D 1 ÷ ( k − g ) = D 0 × (1 + g ) ÷ ( k − g ) = $1.27 × (1.060) ÷ (0.116 − 0.060) = $1.3462 ÷ 0.056 = $24.04 b. The expected price in one year equals the current intrinsic value times 1 plus the growth rate. P 1 = $24.04 × 1.060 = $25.4816 c. Holding period return = ($1.3462 + 25.4816 − $24.0393) ÷ ($24.0393) = 11.60% d. If you are able to purchase the stock for $23.10 instead of its intrinsic value today, the holding period return would be ($1.27 × [1 + 0.060]) + 25.4816 − $23.10 ÷ $23.10 = 16.14%. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

26. Award: 10.00 points Problems? Adjust credit for all students. Round Barn stock has a required return of 8.00% and is expected to pay a dividend of $5.95 next year. Investors expect a growth rate of 4.65% on the dividends for the foreseeable future. Required: a. What is the current fair price for the stock? Note: Round your answer to 2 decimal places. $ Current fair price 177.61 b. The new expectation for the growth rate is 3.40%. If investors are rational, what will be the new price for Round Barn stock? Note: Round your answer to 2 decimal places. $ New price 129.35 Explanation: a. Given the initial values, the fair price for Round Barn is the present value of the growing perpetuity of dividends: $5.95 ÷ (0.08 − 0.0465) = $177.61. b. When the growth rate is revised downward, the new price will be less: $5.95 ÷ (0.08 − 0.0465) = $129.35. This is a result of rational evaluation on the part of shareholders. The stock’s value is sensitive to the inputs used to determine it. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

27. Award: 10.00 points Problems? Adjust credit for all students. CD Bargain Barn is forecasting earnings per share of $3.15 next year. Its investors require a return of 16.5%. Required: a. What is the no-growth value of CD’s stock? Note: Round your answer to 3 decimal places. $ No-growth value 19.091 b. If the stock’s price is currently $44, what is the present value of growth opportunities (PVGO)? Note: Round your answer to 2 decimal places. $ PVGO 24.909 c. What is the implied P/E ratio for CD’s stock? Note: Round your answer to 2 decimal places. Implied P/E ratio 13.97 Explanation: a. The no-growth value of CD’s stock equals E 1 ÷ k = $3.15 ÷ 0.165 = $19.091. b. The present value of growth opportunities equals the current price minus the value if there is no growth. PVGO = $44.00 − 19.091 = $24.909. c. The implied P/E ratio is Worksheet Difficulty: 1 Basic Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 18: Equity Valuation Models > Chapter 18 Additional Algorithmic Problems References

1. Award: 10.00 points 2. Award: 10.00 points 3. Award: 10.00 points 4. Award: 10.00 points _________ is equal to the total market value of the firm's common stock divided by (the replacement cost of the firm's assets less liabilities). Book value per share Liquidation value per share Market value per share Tobin's Q None of the options are correct. Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder would receive in the event of bankruptcy. Market value per share is the market price of the stock. References Multiple Choice Difficulty: 1 Basic High P/E ratios tend to indicate that a company will _________, ceteris paribus. grow quickly grow at the same speed as the average company grow slowly not grow None of the options are correct. Investors pay for growth; hence the high P/E ratio for growth firms; however, the investor should be sure that he or she is paying for expected, not historic, growth. References Multiple Choice Difficulty: 1 Basic _________ is equal to common shareholders' equity divided by common shares outstanding. Book value per share Liquidation value per share Market value per share Tobin's Q None of the options are correct. Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder would receive in the event of bankruptcy. Market value per share is the market price of the stock. Tobin’s Q is equal to the total market value of the firm's common stock divided by the replacement cost of the firm's assets less liabilities. References Multiple Choice Difficulty: 1 Basic _________ are analysts who use information concerning current and prospective profitability of a firm to assess the firm's fair market value. Credit analysts Fundamental analysts Systems analysts Technical analysts Specialists Fundamentalists use all public information in an attempt to value stock (while hoping to identify undervalued securities). References Multiple Choice Difficulty: 1 Basic                        

5. Award: 10.00 points 6. Award: 10.00 points 7. Award: 10.00 points 8. Award: 10.00 points The _________ is defined as the present value of all cash proceeds to the investor in the stock. dividend-payout ratio intrinsic value market-capitalization rate plowback ratio None of the options are correct. The cash flows from the stock discounted at the appropriate rate, based on the perceived riskiness of the stock, the market risk premium, and the risk-free rate, determine the intrinsic value of the stock. References Multiple Choice Difficulty: 1 Basic _________ is the amount of money per common share that could be realized by breaking up the firm, selling the assets, repaying the debt, and distributing the remainder to shareholders. Book value per share Liquidation value per share Market value per share Tobin's Q None of the options are correct. Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder would receive in the event of bankruptcy. Market value per share is the market price of the stock. Tobin’s Q is equal to the total market value of the firm's common stock divided by the replacement cost of the firm's assets less liabilities. References Multiple Choice Difficulty: 1 Basic Since 1955, Treasury bond yields and earnings yields on stocks have been: identical. negatively correlated. positively correlated. uncorrelated. None of the options are correct. The earnings yield on stocks equals the expected real rate of return on the stock market, which should be equal to the yield to maturity on Treasury bonds plus a risk premium, which may change slowly over time. References Multiple Choice Difficulty: 1 Basic Historically, P/E ratios have tended to be: higher when inflation has been high. lower when inflation has been high. uncorrelated with inflation rates but correlated with other macroeconomic variables. uncorrelated with any macroeconomic variables, including inflation rates. None of the options are correct. P/E ratios have tended to be lower when inflation has been high, reflecting the market's assessment that earnings in these periods are of "lower quality," i.e., artificially distorted by inflation, and warranting lower P/E ratios. References Multiple Choice Difficulty: 1 Basic                        

9. Award: 10.00 points 10. Award: 10.00 points 11. Award: 10.00 points 12. Award: 10.00 points The _________ is a common term for the market consensus value of the required return on a stock. dividend payout ratio intrinsic value market capitalization rate plowback rate None of the options are correct. The market capitalization rate, which consists of the risk-free rate, the systematic risk of the stock and the market risk premium, is the rate at which a stock's cash flows are discounted in order to determine intrinsic value. References Multiple Choice Difficulty: 1 Basic The _________ is the fraction of earnings reinvested in the firm. dividend payout ratio, only, retention rate, only, plowback ratio, only, dividend payout ratio and plowback ratio retention rate or plowback ratio Retention rate, or plowback ratio, represents the earnings reinvested in the firm. References Multiple Choice Difficulty: 1 Basic The Gordon model: is a generalization of the perpetuity formula to cover the case of a growing perpetuity, only. is valid only when g is less than k , only. is valid only when k is less than g , only. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k . is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when k is less than g . The Gordon model assumes constant growth indefinitely. Mathematically, g must be less than k ; otherwise, the intrinsic value is undefined. References Multiple Choice Difficulty: 1 Basic You wish to earn a return of 13% on each of two stocks, X and Y. Stock X is expected to pay a dividend of $3 in the upcoming year while stock Y is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock X: will be greater than the intrinsic value of stock Y. will be the same as the intrinsic value of stock Y. will be less than the intrinsic value of stock Y. will be the same or greater than the intrinsic value of stock Y. None of the options are correct. PV 0 = D 1 ÷ ( k − g ) ; given k and g are the same for both firms, the stock with the larger dividend will have the higher value. References Multiple Choice Difficulty: 1 Basic                        

13. Award: 10.00 points 14. Award: 10.00 points 15. Award: 10.00 points 16. Award: 10.00 points You wish to earn a return of 11% on each of two stocks, C and D. Stock C is expected to pay a dividend of $3 in the upcoming year while stock D is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock C: will be greater than the intrinsic value of stock D. will be the same as the intrinsic value of stock D. will be less than the intrinsic value of stock D. will be the same or greater than the intrinsic value of stock D. None of the options are correct. PV 0 = D 1 ÷ ( k − g ) ; given k and g are the same for both firms, the stock with the larger dividend will have the higher value. References Multiple Choice Difficulty: 1 Basic You wish to earn a return of 12% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A: will be greater than the intrinsic value of stock B. will be the same as the intrinsic value of stock B. will be less than the intrinsic value of stock B. will be the same or greater than the intrinsic value of stock B. None of the options are correct. PV 0 = D 1 ÷ ( k − g ) ; given that dividends are equal, the stock with the higher growth rate will have the higher value. References Multiple Choice Difficulty: 1 Basic You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C: will be greater than the intrinsic value of stock D. will be the same as the intrinsic value of stock D. will be less than the intrinsic value of stock D. will be the same or greater than the intrinsic value of stock D. None of the options are correct. PV 0 = D 1 ÷ ( k − g ) ; given that dividends are equal, the stock with the higher growth rate will have the higher value. References Multiple Choice Difficulty: 1 Basic Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year. The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A: will be greater than the intrinsic value of stock B. will be the same as the intrinsic value of stock B. will be less than the intrinsic value of stock B. cannot be calculated without knowing the market rate of return. None of the options are correct. PV 0 = D 1 ÷ ( k − g ) ; given that dividends are equal, the stock with the larger required return will have the lower value. References Multiple Choice Difficulty: 1 Basic                        

17. Award: 10.00 points 18. Award: 10.00 points 19. Award: 10.00 points 20. Award: 10.00 points Each of two stocks, C and D, are expected to pay a dividend of $3 in the upcoming year. The expected growth rate of dividends is 9% for both stocks. You require a rate of return of 10% on stock C and a return of 13% on stock D. The intrinsic value of stock C: will be greater than the intrinsic value of stock D. will be the same as the intrinsic value of stock D. will be less than the intrinsic value of stock D. cannot be calculated without knowing the market rate of return. None of the options are correct. PV 0 = D 1 ÷ ( k − g ) ; given that dividends are equal, the stock with the larger required return will have the lower value. References Multiple Choice Difficulty: 1 Basic If the expected ROE on reinvested earnings is equal to k , the multistage DDM reduces to: V 0 = (Expected dividend yield in year 1) ÷ k . V 0 = (Expected EPS in year 1) ÷ k . V 0 = (Treasury bond yield in year 1) ÷ k . V 0 = (Market return in year 1) ÷ k . None of the options are correct. If ROE = k , no growth is occurring; b = 0; EPS = DPS . References Multiple Choice Difficulty: 2 Intermediate Turtle Corporation has an expected ROE of 10%. The dividend growth rate will be _________ if the firm follows a policy of paying 40% of earnings in the form of dividends. 6.0% 4.8% 7.2% 3.0% None of the options are correct. 10% × 0.60 = 6.0%. References Multiple Choice Difficulty: 1 Basic Melody Corporation has an expected ROE of 14%. The dividend growth rate will be _________ if the firm follows a policy of paying 60% of earnings in the form of dividends. 4.8% 5.6% 7.2% 6.0% None of the options are correct. 14% × 0.40 = 5.6%. References Multiple Choice Difficulty: 1 Basic                        

21. Award: 10.00 points 22. Award: 10.00 points 23. Award: 10.00 points 24. Award: 10.00 points Rigel Corporation has an expected ROE of 16%. The dividend growth rate will be _________ if the firm follows a policy of paying 70% of earnings in the form of dividends. 3.0% 6.0% 7.2% 4.8% None of the options are correct. 16% × 0.30 = 4.8%. References Multiple Choice Difficulty: 1 Basic Zoomer Corporation has an expected ROE of 15%. The dividend growth rate will be _________ if the firm follows a policy of paying 50% of earnings in the form of dividends. 3.0% 4.8% 7.5% 6.0% None of the options are correct. 15% × 0.50 = 7.5%. References Multiple Choice Difficulty: 1 Basic Med-Nac Corporation has an expected ROE of 11%. The dividend growth rate will be _________ if the firm follows a policy of paying 25% of earnings in the form of dividends. 3.0% 4.8% 8.25% 9.0% None of the options are correct. 11% × 0.75 = 8.25%. References Multiple Choice Difficulty: 1 Basic Torie Corporation has an expected ROE of 15%. The dividend growth rate will be _________ if the firm follows a policy of plowing back 75% of earnings. 3.75% 11.25% 8.25% 15.0% None of the options are correct. 15% × 0.75 = 11.25%. References Multiple Choice Difficulty: 1 Basic                        

25. Award: 10.00 points 26. Award: 10.00 points 27. Award: 10.00 points 28. Award: 10.00 points Haw Corporation has an expected ROE of 26%. The dividend growth rate will be _________ if the firm follows a policy of plowing back 90% of earnings. 2.6% 10% 22% 90% None of the options are correct. 26% × 0.90 = 23.4%. References Multiple Choice Difficulty: 1 Basic Keene & Nichols Corporation has an expected ROE of 9%. The dividend growth rate will be _________ if the firm follows a policy of plowing back 10% of earnings. 90% 10% 9% 0.9% None of the options are correct. 9% × 0.10 = 0.9%. References Multiple Choice Difficulty: 1 Basic A preferred stock will pay a dividend of $2.75 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. $0.275 $27.50 $31.82 $56.25 None of the options are correct. PV 0 = D 1 ÷ ( k − g ) = $2.75 ÷ (0.10 − 0.00) = $27.50 References Multiple Choice Difficulty: 2 Intermediate A preferred stock will pay a dividend of $3.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. $33.33 $0.27 $31.82 $56.25 None of the options are correct. PV 0 = D 1 ÷ ( k − g ) = $3.00 ÷ (0.09 − 0.00) = $33.33 References Multiple Choice Difficulty: 2 Intermediate                        

29. Award: 10.00 points 30. Award: 10.00 points 31. Award: 10.00 points 32. Award: 10.00 points A preferred stock will pay a dividend of $1.25 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 12% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. $11.56 $9.65 $11.82 $10.42 None of the options are correct. PV 0 = D 1 ÷ ( k − g ) = $1.25 ÷ (0.12 − 0.00) = $10.42 References Multiple Choice Difficulty: 2 Intermediate A preferred stock will pay a dividend of $3.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 11% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. $0.39 $0.56 $31.82 $56.25 None of the options are correct. PV 0 = D 1 ÷ ( k − g ) = $3.50 ÷ (0.11 − 0.00) = $31.82 References Multiple Choice Difficulty: 2 Intermediate 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. $0.75 $7.50 $64.12 $56.25 None of the options are correct. PV 0 = D 1 ÷ ( k − g ) = $7.50 ÷ (0.10 − 0.00) = $75.00 References Multiple Choice Difficulty: 2 Intermediate 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. $0.60 $6.00 $600 $60.00 None of the options are correct. PV 0 = D 1 ÷ ( k − g ) = $6.00 ÷ (0.10 − 0.00) = $60.00 References Multiple Choice Difficulty: 2 Intermediate                        

33. Award: 10.00 points 34. Award: 10.00 points 35. Award: 10.00 points 36. Award: 10.00 points 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. $30.23 $24.11 $26.52 $27.50 None of the options are correct. 0.10 = (32 − P + 1.25) ÷ P ; 0.10 P = 32 − P + 1.25; 1.10 P = 33.25; P = 30.23. References Multiple Choice Difficulty: 2 Intermediate 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. $23.91 $14.96 $26.52 $27.50 None of the options are correct. HPR = ( P 1 − P 0 + D 1 ) ÷ P 0 0.12 = ($16 − P 0 + $0.75) ÷ P 0 P 0 = $14.96 References Multiple Choice Difficulty: 2 Intermediate 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. $23.91 $24.11 $26.52 $27.50 None of the options are correct. HPR = ( P 1 − P 0 + D 1 ) ÷ P 0 0.15 = ($28 − P 0 + $2.50) ÷ P 0 P 0 = $26.52 References Multiple Choice Difficulty: 2 Intermediate 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. $23.91 $24.11 $26.52 $27.50 None of the options are correct. HPR = ( P 1 − P 0 + D 1 ) ÷ P 0 0.10 = ($42 − P 0 + $3.50) ÷ P 0 P 0 = $41.36 References Multiple Choice Difficulty: 2 Intermediate                        

37. Award: 10.00 points 38. Award: 10.00 points 39. Award: 10.00 points 40. Award: 10.00 points Red Stapler 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. Milton was told the value Red Stapler's book value per share is _________. $1.68 $2.60 $32.14 $60.71 None of the options are correct. P Book = $45,000,000 ÷ 1,400,000 = $32.14 References Multiple Choice Difficulty: 2 Intermediate Red Stapler 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. Milton was told the value Red Stapler's market value per share is _________. $1.68 $2.60 $32.14 $60.71 None of the options are correct. The price of $90 is the market value per share by definition. References Multiple Choice Difficulty: 1 Basic One of the problems with attempting to forecast stock market values is that: there are no variables that seem to predict market return. the earnings multiplier approach can only be used at the firm level. the level of uncertainty surrounding the forecast will always be quite high. dividend-payout ratios are highly variable. None of the options are correct. 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. References Multiple Choice Difficulty: 1 Basic The most popular approach to forecasting the overall stock market is to use: the dividend multiplier. the aggregate return on assets. the historical ratio of book value to market value. the aggregate earnings multiplier. Tobin's Q. The earnings multiplier approach is the most popular approach to forecasting the overall stock market. References Multiple Choice Difficulty: 1 Basic                        

41. Award: 10.00 points 42. Award: 10.00 points 43. Award: 10.00 points 44. Award: 10.00 points Initech 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 Initech shares to be $22 a year from now. The beta of Initech's stock is 1.25. The market's required rate of return on INitech's stock is: 14.0%. 17.5%. 16.5%. 15.25%. None of the options are correct. 4% + 1.25(14% − 4%) = 16.5%. References Multiple Choice Difficulty: 2 Intermediate Initech 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 Initech shares to be $22 a year from now. The beta of Initech's stock is 1.25. What is the intrinsic value of Initech's stock today? $20.60 $20.00 $12.12 $22.00 None of the options are correct. k = r f + × [ E ( r M ) − r f ] = 0.04 + 1.25 × 0.10 = 0.165 k = ( P 1 − P 0 + D 1 ) ÷ P 0 0.165 = ($22 − P 0 + $2) ÷ P 0 P 0 = $20.60 References Multiple Choice Difficulty: 3 Challenge Initech 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%. The beta of Initech's stock is 1.25. If Initech's intrinsic value is $21.00 today, what must be its growth rate? 0.0% 10% 4% 6% 7% k = r f + × [ E ( r M ) − r f ] = 0.04 + 1.25 × 0.10 = 0.165 k = D 1 ÷ P 0 + g 0.165 = $2 ÷ $21 + g g = 0.07 References Multiple Choice Difficulty: 3 Challenge The Mondays Company 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 the Mondays Company has a beta of 1.2. What is the return you should require on The Mondays stock? 12.0% 14.6% 15.6% 20% None of the options are correct. k = r f + × [ E ( r M ) − r f ] = 0.05 + 1.2 × 0.08 = 0.146 References Multiple Choice Difficulty: 2 Intermediate                        

45. Award: 10.00 points 46. Award: 10.00 points 47. Award: 10.00 points 48. Award: 10.00 points The Mondays Company 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 the Mondays Company has a beta of 1.2. What is the intrinsic value of The Mondays stock? $14.29 $14.60 $12.33 $11.62 None of the options are correct. k = r f + β × [ E ( r M ) − r f ] = 0.05 + 1.2 × 0.08 = 0.146 P 0 = D 1 ÷ ( k − g ) = $1.00 ÷ (0.146 − 0.06) = $11.62 References Multiple Choice Difficulty: 3 Challenge Milton Travel Corporation is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Milton Travel Corporation has a beta of 3.00. The return you should require on the stock is: 10%. 18%. 30%. 42%. None of the options are correct. k = r f + β × [ E ( r M ) − r f ] = 0.06 + 3 × 0.08 = 0.30 References Multiple Choice Difficulty: 2 Intermediate Slow Silver Scuba Corporation is expected to pay a dividend of $8 in the upcoming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Slow Silver Scuba Corporation has a beta of − 0.25. The return you should require on the stock is: 2%. 4%. 6%. 8%. None of the options are correct. k = r f + β × [ E ( r M ) − r f ] = 0.06 − 0.25 × 0.08 = 0.04 References Multiple Choice Difficulty: 2 Intermediate Salted Chips Company is expected to have EPS in the coming year of $2.50. The expected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 70%, the growth rate of dividends should be: 5.00%. 6.25%. 6.60%. 7.50%. 8.75%. 12.5% × 0.7 = 8.75%. References Multiple Choice Difficulty: 1 Basic                        

49. Award: 10.00 points 50. Award: 10.00 points 51. Award: 10.00 points 52. Award: 10.00 points A company paid a dividend last year of $1.75. The expected ROE for next year is 14.5%. An appropriate required return on the stock is 10%. If the firm has a plowback ratio of 75%, the dividend in the coming year should be: $1.80. $2.12. $1.77. $1.94. None of the options are correct. g = ROE × b = 0.145 × 0.75 = 0.10875 D 1 = D 0 × (1 + g ) = $1.75 × (1.10875) = $1.94 References Multiple Choice Difficulty: 2 Intermediate Salted Chips Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be: $1.00. $2.50. $2.69. $2.81. None of the options are correct. g = ROE × b = 0.125 × 0.6 = 0.075 D 1 = D 0 × (1 + g ) = $2.50 × (1.075) = $2.69 References Multiple Choice Difficulty: 2 Intermediate Suppose that the average P/E multiple in the oil industry is 20. Non-Standard Oil Corporation is expected to have an EPS of $3.00 in the coming year. The intrinsic value of Non-Standard Oil Corporation stock should be: $28.12. $35.55. $60.00. $72.00. None of the options are correct. 20 × $3.00 = $60.00. References Multiple Choice Difficulty: 1 Basic Suppose that the average P/E multiple in the oil industry is 22. Exxon is expected to have an EPS of $1.50 in the coming year. The intrinsic value of Exxon stock should be: $33.00. $35.55. $63.00. $72.00. None of the options are correct. 22 × $1.50 = $33.00. References Multiple Choice Difficulty: 1 Basic                        

53. Award: 10.00 points 54. Award: 10.00 points 55. Award: 10.00 points 56. Award: 10.00 points Suppose that the average P/E multiple in the software industry is 16. Intertrade Corporation is expected to have an EPS of $4.50 in the coming year. The intrinsic value of Intertrade Corporation stock should be: $28.12. $35.55. $63.00. $72.00. None of the options are correct. 16 × $4.50 = $72.00. References Multiple Choice Difficulty: 1 Basic Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to have an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be: $28.12. $93.50. $63.00. $72.00. None of the options are correct. 17 × $5.50 = $93.50. References Multiple Choice Difficulty: 1 Basic An analyst has determined that the intrinsic value of VM CORPORATION stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of VM CORPORATION in the coming year is: $3.63. $4.44. $0.80. $22.50. None of the options are correct. $20(1 ÷ 25) = $0.80. References Multiple Choice Difficulty: 1 Basic An analyst has determined that the intrinsic value of Dell stock is $34 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year will be: $3.63. $4.44. $14.40. $1.26. None of the options are correct. $34(1 ÷ 27) = $1.26. References Multiple Choice Difficulty: 1 Basic                        

57. Award: 10.00 points 58. Award: 10.00 points 59. Award: 10.00 points 60. Award: 10.00 points An analyst has determined that the intrinsic value of Coca Cola stock is $80 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 22, then it would be reasonable to assume the expected EPS of Coca Cola in the coming year is: $3.64. $4.44. $14.40. $22.50. None of the options are correct. $80(1 ÷ 22) = $3.64. References Multiple Choice Difficulty: 1 Basic Thrones Dragon Company is expected to pay a dividend of $8 in the coming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Thrones Dragon Company has a beta of − 0.25. The intrinsic value of the stock is: $80.00. $133.33. $200.00. $400.00. None of the options are correct. k = r f + β × [ E ( r M ) − r f ] = 0.06 + −0.25 × 0.08 = 0.04 P 0 = D 1 ÷ ( k − g ) = $8.00 ÷ (0.04 + 0.02) = $133.33 References Multiple Choice Difficulty: 3 Challenge No Fly Airlines is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of No Fly Airlines has a beta of 3.00. The intrinsic value of the stock is: $46.67. $50.00. $56.00. $62.50. None of the options are correct. k = r f + β × [ E ( r M ) − r f ] = 0.06 + 3 × 0.08 = 0.30 P 0 = $7.00 ÷ (0.30 − 0.15) = $46.67 References Multiple Choice Difficulty: 2 Intermediate Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is: $10.71. $15.00. $17.75. $25.00. None of the options are correct. k = r f + β × [ E ( r M ) − r f ] = 0.06 + 0.75 × 0.08 = 0.12 P 0 = $1.50 ÷ (0.12 − 0.06) = $25.00 References Multiple Choice Difficulty: 2 Intermediate                        

61. Award: 10.00 points 62. Award: 10.00 points 63. Award: 10.00 points 64. Award: 10.00 points Low Tech Chip Company is expected to have EPS of $2.50 in the coming year. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be: $22.73. $27.50. $28.57. $38.46. None of the options are correct. g = ROE × b = 0.14 × 0.6 = 0.084 D 1 = E 1 × (1 − b) = $2.50 × 0.4 = $1.00 P 0 = $1.00 ÷ (0.11 − 0.084) = $38.46 References Multiple Choice Difficulty: 3 Challenge Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00. What is the market-capitalization rate for Risk Metrics? 13.6% 13.9% 15.6% 16.9% None of the options are correct. k = D 1 ÷ P 0 + g = $3.50 ÷ $90.00 + 0.10 = 0.139 References Multiple Choice Difficulty: 2 Intermediate Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00. What is the approximate beta of Risk Metrics's stock? 0.8 1.0 1.1 1.4 None of the options are correct. k = D 1 ÷ P 0 + g = $3.50 ÷ $90.00 + 0.10 = 0.139 k = r f + β × [ E ( r M ) − r f ] 0.139 = 0.05 + β × (0.13 − 0.05) β = 1.11 References Multiple Choice Difficulty: 2 Intermediate The market-capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13%, and the expected EPS are $3.60. If the firm's plowback ratio is 50%, the P/E ratio will be: 7.69. 8.33. 9.09. 11.11. None of the options are correct. g = ROE × b = 0.13 × 0.5 = 0.065 P 0 ÷ E 1 = (1 − b ) ÷ ( k − g ) = (1 − 0.5) ÷ (0.12 − 0.065) = 9.09 References Multiple Choice Difficulty: 3 Challenge                        

65. Award: 10.00 points 66. Award: 10.00 points 67. Award: 10.00 points The market-capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13%, and the expected EPS are $3.60. If the firm's plowback ratio is 75%, the P/E ratio will be: 7.69. 8.33. 9.09. 11.11. None of the options are correct. g = ROE × b = 0.13 × 0.75 = 0.0975 P 0 ÷ E 1 = (1 − b ) ÷ ( k − g ) = (1 − 0.75) ÷ (0.12 − 0.0975) = 11.11 References Multiple Choice Difficulty: 3 Challenge The market-capitalization rate on the stock of Fast Growing Company is 20%. The expected ROE is 22%, and the expected EPS are $6.10. If the firm's plowback ratio is 90%, the P/E ratio will be: 7.69. 8.33. 9.09. 11.11. 50.00. g = ROE × b = 0.22 × 0.90 = 0.198 P 0 ÷ E 1 = (1 − b ) ÷ ( k − g ) = (1 − 0.9) ÷ (0.20 − 0.198) = 50.00 References Multiple Choice Difficulty: 3 Challenge JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _________ today. $33.00 $40.67 $71.80 $66.00 None of the options are correct. Year Dividend PV of Dividend@11% 1 $ 1.65 $1.65 ÷ 1.11 = $ 1.4865 2 $ 1.97 $1.97 ÷ (1.11) 2 = $ 1.5989 3 $ 2.54 $2.54 ÷ (1.11) 3 = $ 1.8572 Sum $ 4.94 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($1.65 ÷ (1.11) 1 ) + ($1.97 ÷ (1.11) 2 ) + ($2.54 ÷ (1.11) 3 ) + ((($2.54 × (1.08)) ÷ (0.11 − 0.08)) ÷ (1.11) 3 ) = $71.80 References Multiple Choice Difficulty: 3 Challenge                  

68. Award: 10.00 points 69. Award: 10.00 points 70. Award: 10.00 points Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _________ today. $33.00 $39.86 $55.00 $66.00 $40.68 Calculations are shown in the table below. Year Dividend PV of Dividend@14% 1 $ 1.20 $1.20 ÷ 1.14 = $ 1.0526 2 $ 1.50 $1.50 ÷ (1.14) 2 = $ 1.1542 3 $ 2.00 $2.00 ÷ (1.14) 3 = $ 1.3499 Sum $ 3.56 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k - g )) = ($1.20 ÷ (1.14) 1 ) + ($1.50 ÷ (1.14) 2 ) + ($2.00 ÷ (1.14) 3 ) + ((($2.00 × (1.10)) ÷ (0.14 − 0.10)) ÷ (1.14) 3 ) = $40.68 References Multiple Choice Difficulty: 3 Challenge Antiquated Products Corporation produces goods that are very mature in their product life cycles. Antiquated Products Corporation is expected to pay a dividend in year 1 of $1.00, a dividend of $0.90 in year 2, and a dividend of $0.85 in year 3. After year 3, dividends are expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. The stock should be worth: $8.98. $10.57. $20.00. $22.22. None of the options are correct. Calculations are shown below. Year Dividend PV of Dividend@8% 1 $ 1.00 $1.00 ÷ 1.08 = $ 0.9259 2 $ 0.90 $0.90 ÷ (1.08) 2 = $ 0.7716 3 $ 0.85 $0.85 ÷ (1.08) 3 = $ 0.6748 Sum $ 2.3723 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($1.00 ÷ (1.08) 1 ) + ($0.90 ÷ (1.08) 2 ) + ($0.85 ÷ (1.08) 3 ) + ((($0.85 × (0.98)) ÷ (0.08 − 0.02)) ÷ (1.08) 3 ) = $8.98 References Multiple Choice Difficulty: 3 Challenge Mature Products Corporation produces goods that are very mature in their product life cycles. Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a dividend of $1.50 in year 2, and a dividend of $1.00 in year 3. After year 3, dividends are expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth: $9.00. $10.57. $20.00. $22.22. None of the options are correct. Calculations are shown below. Year Dividend PV of Dividend@10% 1 $ 2.00 $2.00 ÷ 1.10 = $ 1.8182 2 $ 1.50 $1.50 ÷ (1.10) 2 = $ 1.2397 3 $ 1.00 $1.00 ÷ (1.10) 3 = $ 0.7513 Sum $ 3.8090 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($2.00 ÷ (1.10) 1 ) + ($1.50 ÷ (1.10) 2 ) + ($1.00 ÷ (1.10) 3 ) + ((($1.00 × (0.99)) ÷ (0.10 − 0.01)) ÷ (1.10) 3 ) = $10.57 References Multiple Choice Difficulty: 3 Challenge                  

71. Award: 10.00 points 72. Award: 10.00 points 73. Award: 10.00 points Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market-capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The projected free cash flow of Utica Manufacturing Company for the coming year is: $150,000. $180,000. $300,000. $380,000. None of the options are correct. Calculations are shown below. Before-tax cash flow from operations $ 500,000 − Depreciation 100,000 Taxable Income 400,000 − Taxes (30%) 120,000 After-tax unleveraged income 280,000 After-tax unlevered income + depreciation 380,000 − New investment 200,000 Free cash flow $ 180,000 References Multiple Choice Difficulty: 3 Challenge Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total value of the equity of Utica Manufacturing Company should be: $1,000,000. $2,000,000. $3,000,000. $4,000,000. None of the options are correct. Before-tax cash flow from operations $ 500,000 − Depreciation 100,000 Taxable Income 400,000 − Taxes (30%) 120,000 After-tax unleveraged income 280,000 After-tax unlevered income + depreciation 380,000 − New investment 200,000 Free cash flow $ 180,000 V 0 = FCF ÷ ( K − g ) = $180,000 ÷ (0.15 − 0.06) = $2,000,000 References Multiple Choice Difficulty: 3 Challenge A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90. Given this information, it follows that: the stock experienced a drop in the P/E ratio. the firm had a decrease in dividend-payout ratio. the firm increased the number of shares outstanding. the required rate of return decreased. None of the options are correct. $80 ÷ $10 = 8; $90 ÷ $12 = 7.5. References Multiple Choice Difficulty: 2 Intermediate                  

74. Award: 10.00 points 75. Award: 10.00 points 76. Award: 10.00 points 77. Award: 10.00 points In the dividend discount model, which of the following are not incorporated into the discount rate? Real risk-free rate Risk premium for stocks Return on assets Expected inflation rate None of the options are correct. The real risk-free rate, risk premium for stocks, and expected inflation rate are incorporated into the discount rate used in the dividend discount model. References Multiple Choice Difficulty: 2 Intermediate A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index most likely has: an anticipated earnings growth rate which is less than that of the average firm. a dividend yield which is less than that of the average firm. less predictable earnings growth than that of the average firm. greater cyclicality of earnings growth than that of the average firm. None of the options are correct. Firms with lower than average dividend yields are usually growth firms, which have a higher P/E ratio than average. References Multiple Choice Difficulty: 2 Intermediate Other things being equal, a low _________ would be most consistent with a relatively high growth rate of firm earnings. dividend-payout ratio degree of financial leverage variability of earnings inflation rate None of the options are correct. Firms with high growth rates are retaining most of the earnings for growth; thus, the dividend payout ratio will be low. References Multiple Choice Difficulty: 2 Intermediate A firm has a return on equity of 14% and a dividend-payout ratio of 60%. The firm's anticipated growth rate is: 5%. 10%. 14%. 20%. None of the options are correct. 14% × 0.40 = 5.6%. References Multiple Choice Difficulty: 1 Basic                        

78. Award: 10.00 points 79. Award: 10.00 points 80. Award: 10.00 points A firm has a return on equity of 20% and a dividend-payout ratio of 30%. The firm's anticipated growth rate is: 6%. 10%. 14%. 20%. None of the options are correct. 20% × 0.70 = 14%. References Multiple Choice Difficulty: 1 Basic Sales Company paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future. If the firm is expected to generate a 10% return on equity in the future, and if you require a 12% return on the stock, the value of the stock is: $17.67. $13.00. $16.67. $18.67. None of the options are correct. g = ROE × b = 0.10 × 0.6 = 0.06 P 0 = ($1.00 × 1.06) ÷ (0.12 − 0.06) = $17.67 References Multiple Choice Difficulty: 2 Intermediate Assume that Malnava Company will pay a $2.00 dividend per share next year, an increase from the current dividend of $1.50 per share that was just paid. After that, the dividend is expected to increase at a constant rate of 5%. If you require a 12% return on the stock, the value of the stock is: $28.57. $28.79. $30.00. $31.78. None of the options are correct. P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($2.00 ÷ (1.12) 1 ) + ((($2.00 × (1.05)) ÷ (0.12 − 0.05)) ÷ (1.12) 1 ) = $28.57 References Multiple Choice Difficulty: 3 Challenge                  

81. Award: 10.00 points 82. Award: 10.00 points 83. Award: 10.00 points The growth in dividends of Music Doctors, Incorporated is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years. After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on Music Doctors, Incorporated is 11%. Last year's dividends per share were $2.75. What should the stock sell for today? $8.99 $25.21 $39.71 $110.00 None of the options are correct. P 5 = 3.7164 ÷ (0.11 − 0.03) = $46.4544; PV of P 5 = $46.4544 ÷ (1.11) 5 = $27.5684; P O = $12.1449 + $27.5684 = $39.71. Calculations are shown below Year Dividend PV of Dividend@11% 1 $2.75(1.08) $2.97 ÷ 1.11 = $ 2.6757 2 $2.75(1.08) 2 $3.21 ÷ (1.11) 2 = $ 2.6034 3 $2.75(1.08) 2 (1.04) $3.34 ÷ (1.11) 3 = $ 2.4392 4 $2.75(1.08) 2 (1.04) 2 $3.47 ÷ (1.11) 4 = $ 2.2854 5 $2.75(1.08) 2 (1.04) 3 $3.61 ÷ (1.11) 5 = $ 2.1412 Sum $ 12.1449 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = (($2.75 × 1.08) ÷ (1.11) 1 ) + (($2.75 × 1.08 2 ) ÷ (1.11) 2 ) + (($2.75 × 1.08 2 × 1.04) ÷ (1.11) 3 ) + (($2.75 × (1.08) 2 × (1.04) 2 ) ÷ (1.11) 4 ) + (($2.75 × (1.08) 2 × (1.04) 3 ) ÷ (1.11) 5 ) + ((($2.75 × (1.08) 2 × (1.04) 3 × 1.03) ÷ (0.11 − 0.03)) ÷ (1.11) 5 ) = $39.71 References Multiple Choice Difficulty: 3 Challenge The growth in dividends of ABC, Incorporated is expected to be 15% per year for the next three years, followed by a growth rate of 8% per year for two years. After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on ABC, Incorporated is 13%. Last year's dividends per share were $1.85. What should the stock sell for today? $8.99 $25.21 $40.00 $27.74 None of the options are correct. P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = (($1.85 × 1.15) ÷ (1.13) 1 ) + (($1.85 × 1.15 2 ) ÷ (1.13) 2 ) + (($1.85 × 1.15 3 ) ÷ (1.13) 3 ) + (($1.85 × (1.15) 3 × (1.08) 1 ) ÷ (1.13) 4 ) + (($1.85 × 1.15 3 × 1.08 2 ) ÷ (1.13) 5 ) + ((($1.85 × (1.15) 3 × (1.08) 2 × 1.03) ÷ (0.13 − 0.03)) ÷ (1.13) 5 ) = $27.74 References Multiple Choice Difficulty: 3 Challenge The growth in dividends of XYZ, Incorporated is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years. After this five-year period, the growth in dividends is expected to be 2% per year, indefinitely. The required rate of return on XYZ, Incorporated is 12%. Last year's dividends per share were $2.00. What should the stock sell for today? $8.99 $25.21 $40.00 $110.00 None of the options are correct. Calculations are shown below: Year Dividend PV of Dividend@12% 1 $2.00(1.10) $2.22 ÷ 1.12 = $ 1.96 2 $2.00(1.10) 2 $2.42 ÷ (1.12) 2 = $ 1.90 3 $2.00(1.10) 2 (1.05) $2.54 ÷ (1.12) 3 = $ 1.81 4 $2.00(1.10) 2 (1.05) 2 $2.67 ÷ (1.12) 4 = $ 1.70 5 $2.00(1.10) 2 (1.05) 3 $2.80 ÷ (1.12) 5 = $ 1.59 Sum $ 8.99 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = (($2.00 × 1.10) ÷ (1.12) 1 ) + (($2.00 × 1.10 2 ) ÷ (1.12) 2 ) + (($2.00 × 1.10 2 × 1.05) ÷ (1.12) 3 ) + (($2.00 × (1.10) 2 × (1.05) 2 ) ÷ (1.12) 4 ) + (($2.00 × 1.10 2 × 1.05 3 ) ÷ (1.12) 5 ) + ((($2.00 × (1.10) 2 × (1.05) 3 × 1.02) ÷ (0.12 − 0.02)) ÷ (1.12) 5 )) = $25.21 References Multiple Choice Difficulty: 3 Challenge                  

84. Award: 10.00 points 85. Award: 10.00 points 86. Award: 10.00 points 87. Award: 10.00 points If a firm has a required rate of return equal to the ROE, the firm can increase market price and P/E by retaining more earnings. the firm can increase market price and P/E by increasing the growth rate. the amount of earnings retained by the firm does not affect market price or the P/E. the firm can increase market price and P/E by retaining more earnings and increasing the growth rate. None of the options are correct. If required return and ROE are equal, investors are indifferent as to whether the firm retains more earnings or increases dividends. Thus, retention rates and growth rates do not affect market price and P/E. References Multiple Choice Difficulty: 1 Basic According to James Tobin, the long-run value of Tobin's Q should move toward: 0. 1. 2. infinity. None of the options are correct. According to Tobin, in the long run the ratio of market price to replacement cost should tend toward 1. References Multiple Choice Difficulty: 1 Basic The goal of fundamental analysts is to find securities: whose intrinsic value exceeds market price. with a positive present value of growth opportunities. with high market capitalization rates. All of the options are correct. None of the options are correct. The goal of analysts is to find an undervalued security. References Multiple Choice Difficulty: 1 Basic The dividend discount model: ignores capital gains. incorporates the after-tax value of capital gains. includes capital gains implicitly. restricts capital gains to a minimum. None of the options are correct. The DDM includes capital gains implicitly, as the selling price at any point is based on the forecast of future dividends. References Multiple Choice Difficulty: 2 Intermediate                        

88. Award: 10.00 points 89. Award: 10.00 points 90. Award: 10.00 points 91. Award: 10.00 points Many stock analysts assume that a mispriced stock will: immediately return to its intrinsic value. return to its intrinsic value within a few days. never return to its intrinsic value. gradually approach its intrinsic value over several years. None of the options are correct. Many analysts assume that mispricing may take several years to gradually correct. References Multiple Choice Difficulty: 2 Intermediate Investors want high plowback ratios: for all firms. whenever ROE > k . whenever k > ROE . only when they are in low tax brackets. whenever bank interest rates are high. Investors prefer that firms reinvest earnings when ROE exceeds k . References Multiple Choice Difficulty: 1 Basic Because the DDM requires multiple estimates, investors should: carefully examine inputs to the model, only. perform sensitivity analysis on price estimates, only. not use this model without expert assistance, only. feel confident that DDM estimates are correct, only. carefully examine inputs to the model and perform sensitivity analysis on price estimates. Small errors in input estimates can result in large pricing errors using the DDM . Therefore, investors should carefully examine input estimates and perform sensitivity analysis on the results. References Multiple Choice Difficulty: 1 Basic According to Peter Lynch, a rough rule of thumb for security analysis is that: the growth rate should be equal to the plowback rate. the growth rate should be equal to the dividend-payout rate. the growth rate should be low for emerging industries. the growth rate should be equal to the P/E ratio. None of the options are correct. A rough guideline is that P/E ratios should equal growth rates in dividends or earnings. References Multiple Choice Difficulty: 2 Intermediate                        

92. Award: 10.00 points 93. Award: 10.00 points 94. Award: 10.00 points 95. Award: 10.00 points Dividend discount models and P/E ratios are used by _________ to try to find mispriced securities. technical analysts statistical analysts fundamental analysts dividend analysts psychoanalysts Fundamental analysts look at the basic features of the firm to estimate firm value. References Multiple Choice Difficulty: 1 Basic Which of the following is the best measure of the floor for a stock price? Book value Liquidation value Replacement cost Market value Tobin's Q If the firm's market value drops below the liquidation value the firm will be a possible takeover target. It would be worth more liquidated than as a going concern. References Multiple Choice Difficulty: 1 Basic Who popularized the dividend discount model, which is sometimes referred to by his name? Burton Malkiel Frederick Macaulay Harry Markowitz Marshall Blume Myron Gordon The dividend discount model is also called the Gordon model. References Multiple Choice Difficulty: 1 Basic If a firm follows a low-investment-rate plan (applies a low plowback ratio), its dividends will be _________ now and _________ in the future than a firm that follows a high-reinvestment-rate plan. higher; higher lower; lower lower; higher higher; lower It is not possible to tell. By retaining less of its income for plowback, the firm is able to pay more dividends initially. But this will lead to a lower growth rate for dividends and a lower level of dividends in the future relative to a firm with a high-reinvestment- rate plan. References Multiple Choice Difficulty: 2 Intermediate                        

96. Award: 10.00 points 97. Award: 10.00 points 98. Award: 10.00 points 99. Award: 10.00 points The present value of growth opportunities (PVGO) is equal to: 1. the difference between a stock's price and its no-growth value per share. 2. the stock's price. 3. zero if its return on equity equals the discount rate. 4. the net present value of future investment opportunities. 1 and 4 2 and 4 1, 3, and 4 2, 3, and 4 3 and 4 All are correct except 2—the stock's price equals the no-growth value per share plus the PVGO. References Multiple Choice Difficulty: 2 Intermediate Low P/E ratios tend to indicate that a company will _________, ceteris paribus. grow quickly grow at the same speed as the average company grow slowly P/E ratios are unrelated to growth. None of the options are correct. Investors pay for growth; hence a relatively high P/E ratio for growth firms. References Multiple Choice Difficulty: 1 Basic Earnings management is: when management makes changes in the operations of the firm to ensure that earnings do not increase or decrease too rapidly. when management makes changes in the operations of the firm to ensure that earnings do not increase too rapidly. when management makes changes in the operations of the firm to ensure that earnings do not decrease too rapidly. the practice of using flexible accounting rules to improve the apparent profitability of the firm. None of the options are correct. Earnings management is the practice of using flexible accounting rules to improve the apparent profitability of the firm. References Multiple Choice Difficulty: 1 Basic A version of earnings management that became common in the 1990s was: when management made changes in the operations of the firm to ensure that earnings did not increase or decrease too rapidly. reported "pro forma earnings." when management made changes in the operations of the firm to ensure that earnings did not increase too rapidly. when management made changes in the operations of the firm to ensure that earnings did not decrease too rapidly. None of the options are correct. A version of earnings management that became common in the 1990s was reporting "pro forma earnings." References Multiple Choice Difficulty: 1 Basic                        

100. Award: 10.00 points 101. Award: 10.00 points 102. Award: 10.00 points 103. Award: 10.00 points GAAP allows: no leeway to manage earnings. minimal leeway to manage earnings. considerable leeway to manage earnings. earnings management if it is beneficial in increasing stock price. None of the options are correct. GAAP allows considerable leeway to manage earnings. References Multiple Choice Difficulty: 1 Basic The most appropriate discount rate to use when applying a FCFE valuation model is the: required rate of return on equity. WACC. risk-free rate. None of the options are correct. The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity. References Multiple Choice Difficulty: 1 Basic WACC is the most appropriate discount rate to use when applying a _________ valuation model. FCFF FCFE DDM FCFF or DDM, depending on the debt level of the firm, P/E The most appropriate discount rate to use when applying a FCFF valuation model is the WACC. References Multiple Choice Difficulty: 1 Basic The most appropriate discount rate to use when applying a FCFF valuation model is the: required rate of return on equity. WACC. risk-free rate. required rate of return on equity or risk-free rate, depending on the debt level of the firm. None of the options are correct. The most appropriate discount rate to use when applying a FCFF valuation model is the WACC. References Multiple Choice Difficulty: 1 Basic                       

104. Award: 10.00 points 105. Award: 10.00 points 106. Award: 10.00 points 107. Award: 10.00 points The required rate of return on equity is the most appropriate discount rate to use when applying a _________ valuation model. FCFE FCEF WACC FCEF or WACC P/E The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity. References Multiple Choice Difficulty: 1 Basic Siri had a FCFE of $1.6M last year and has 3.2M shares outstanding. Siri's required return on equity is 12%, and WACC is 9.8%. If FCFE is expected to grow at 9% forever, the intrinsic value of Siri's shares is: $68.13. $18.17. $26.35. $14.76. None of the options are correct. FCFE 0 per share = $1,600,000 ÷ 3,200,000 = $0.50 FCFE 1 per share = $0.50 × (1 + 0.09) = $0.545 V 0 = $0.545 ÷ (0.12 − 0.09) = $18.17 References Multiple Choice Difficulty: 2 Intermediate Zero had a FCFE of $4.5M last year and has 2.25M shares outstanding. Zero's required return on equity is 10%, and WACC is 8.2%. If FCFE is expected to grow at 8% forever, the intrinsic value of Zero's shares is: $108.00. $1,080.00. $26.35. $14.76. None of the options are correct. FCFE 0 per share = $4,500,000 ÷ 2,250,000 = $2.00 FCFE 1 per share = $2.00 × (1 + 0.08) = $2.16 V 0 = $2.16 ÷ (0.10 − 0.08) = $108.00 References Multiple Choice Difficulty: 2 Intermediate See Candy had a FCFE of $6.1M last year and has 2.32M shares outstanding. See's required return on equity is 10.6%, and WACC is 9.3%. If FCFE is expected to grow at 6.5% forever, the intrinsic value of See's shares is: $108.00. $68.30. $26.35. $14.76. None of the options are correct. FCFE 0 per share = $6,100,000 ÷ 2,320,000 = $2.63 FCFE 1 per share = $2.63 × (1 + 0.065) = $2.80 V 0 = $2.80 ÷ (0.106 − 0.065) = $68.30 References Multiple Choice Difficulty: 2 Intermediate                        

108. Award: 10.00 points 109. Award: 10.00 points 110. Award: 10.00 points 111. Award: 10.00 points SI International had a FCFE of $122.1M last year and has 12.43M shares outstanding. SI's required return on equity is 11.3%, and WACC is 9.8%. If FCFE is expected to grow at 7.0% forever, the intrinsic value of SI's shares is: $108.00. $68.29. $244.43. $14.76. FCFE 0 per share = $122,100,000 ÷ 12,430,000 = $9.82 FCFE 1 per share = $9.82 × (1 + 0.07) = $10.51 V 0 = $10.51 ÷ (0.113 − 0.07) = $244.43 References Multiple Choice Difficulty: 2 Intermediate Highpoint had a FCFE of $246M last year and has 123M shares outstanding. Highpoint's required return on equity is 10%, and WACC is 9%. If FCFE is expected to grow at 8.0% forever, the intrinsic value of Highpoint's shares is: $21.60. $108. $244.42. $216.00. None of the options are correct. FCFE 0 per share = $246,000,000 ÷ 123,000,000 = $2.00 FCFE 1 per share = $2.00 × (1 + 0.08) = $2.16 V 0 = $2.16 ÷ (0.10 − 0.08) = $108.00 References Multiple Choice Difficulty: 2 Intermediate SGA Consulting had a FCFE of $3.2M last year and has 3.2M shares outstanding. SGA's required return on equity is 13%, and WACC is 11.5%. If FCFE is expected to grow at 8.5% forever, the intrinsic value of SGA's shares is: $21.60. $26.56. $244.42. $24.11. None of the options are correct. FCFE 0 per share = $3,200,000 ÷ 3,200,000 = $1.00 FCFE 1 per share = $1.00 × (1 + 0.085) = $1.085 V 0 = $1.085 ÷ (0.13 − 0.085) = $24.11 References Multiple Choice Difficulty: 2 Intermediate Seaman had a FCFE of $4.6B last year and has 113.2M shares outstanding. Seaman's required return on equity is 11.6%, and WACC is 10.4%. If FCFE is expected to grow at 5% forever, the intrinsic value of Seaman's shares is: $646.48. $64.66. $6,464.80. $6.46. None of the options are correct. FCFE 0 per share = $4,600,000,000 ÷ 113,200,000 = $40.64 FCFE 1 per share = $40.64 × (1 + 0.05) = $42.67 V 0 = $42.67 ÷ (0.116 − 0.05) = $646.48 References Multiple Choice Difficulty: 2 Intermediate                       

112. Award: 10.00 points 113. Award: 10.00 points 114. Award: 10.00 points Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The projected free cash flow of F&G Manufacturing Company for the coming year is: $250,000. $180,000. $300,000. $380,000. None of the options are correct. Calculations are shown below. Before-tax cash flow from operations $ 750,000 − Depreciation 125,000 Taxable Income 625,000 − Taxes (40%) 250,000 After-tax unleveraged income 375,000 After-tax unlevered income + depreciation 500,000 − New investment 250,000 Free cash flow $ 250,000 References Multiple Choice Difficulty: 3 Challenge Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The total value of the equity of F&G Manufacturing Company should be: $1,615,157. $2,479,169. $3,333,333. $4,166,667. None of the options are correct. Before-tax cash flow from operations $ 750,000 − Depreciation 125,000 Taxable Income 625,000 − Taxes (40%) 250,000 After-tax unleveraged income 375,000 After-tax unlevered income + depreciation 500,000 − New investment 250,000 Free cash flow $ 250,000 V 0 = FCF ÷ ( k − g ) = $250,000 ÷ (0.13 − 0.07) = $4,166,667 References Multiple Choice Difficulty: 3 Challenge Boaters World is expected to have per share FCFE in year 1 of $1.65, per share FCFE in year 2 of $1.97, and per share FCFE in year 3 of $2.54. After year 3, per share FCFE is expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _________ today. $77.53 $40.67 $82.16 $71.80 None of the options are correct. Calculations are shown in the table below. Year FCFE PV of FCFE@11% 1 $ 1.65 $ 1.65 ÷ 1.11 = $ 1.4865 2 $ 1.97 $1.97 ÷ (1.11) 2 = $ 1.5989 3 $ 2.54 $2.54 ÷ (1.11) 3 = $ 1.8572 Sum $ 4.94 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($1.65 ÷ (1.11) 1 ) + ($1.97 ÷ (1.11) 2 ) + ($2.54 ÷ (1.11) 3 ) + (($2.54 × (1.08)) ÷ (0.11 − 0.08)) ÷ (1.11) 3 ) = $71.80 References Multiple Choice Difficulty: 3 Challenge                  

115. Award: 10.00 points 116. Award: 10.00 points 117. Award: 10.00 points Smart Draw Company is expected to have per share FCFE in year 1 of $1.20, per share FCFE in year 2 of $1.50, and per share FCFE in year 3 of $2.00. After year 3, per share FCFE is expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _________ today. $33.00 $40.68 $55.00 $66.00 $12.16 Calculations are shown in the table below. Year FCFE PV of FCFE@14% 1 $ 1.20 $1.20 ÷ 1.14 = $ 1.0526 2 $ 1.50 $1.50 ÷ (1.14) 2 = $ 1.1542 3 $ 2.00 $2.00 ÷ (1.14) 3 = $ 1.3499 Sum $ 3.56 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($1.20 ÷ (1.14) 1 ) + ($1.50 ÷ (1.14) 2 ) + ($2.00 ÷ (1.14) 3 ) + (($2.00 × (1.10)) ÷ (0.14 − 0.10)) ÷ (1.14) 3 ) = $40.68 References Multiple Choice Difficulty: 3 Challenge Old Style Corporation produces goods that are very mature in their product life cycles. Old Style Corporation is expected to have per share FCFE in year 1 of $1.00, per share FCFE of $0.90 in year 2, and per share FCFE of $0.85 in year 3. After year 3, per share FCFE is expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. The stock should be worth _________ today. $127.63 $10.57 $20.00 $22.22 None of the options are correct. Calculations are shown below. Year FCFE PV of FCFE@8% 1 $ 1.00 $1.00 ÷ 1.08 = $ 0.9259 2 $ 0.90 $0.90 ÷ (1.08) 2 = $ 0.7716 3 $ 0.85 $0.85 ÷ (1.08) 3 = $ 0.6748 Sum $ 2.3723 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($1.00 ÷ (1.08) 1 ) + ($0.90 ÷ (1.08) 2 ) + ($0.85 ÷ (1.08) 3 ) + (($0.85 × (0.98)) ÷ (0.08 + 0.02)) ÷ (1.08) 3 ) = $8.98 References Multiple Choice Difficulty: 3 Challenge Jovy Corporation produces goods that are very mature in their product life cycles. Jovy Corporation is expected to have per share FCFE in year 1 of $2.00, per share FCFE of $1.50 in year 2, and per share FCFE of $1.00 in year 3. After year 3, per share FCFE is expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth _________ today. $9.00 $101.57 $10.57 $22.22 $47.23 Calculations are shown below. Year FCFE PV of FCFE@10% 1 $ 2.00 $2.00 ÷ 1.10 = $ 1.8182 2 $ 1.50 $1.50 ÷ (1.10) 2 = $ 1.2397 3 $ 1.00 $1.00 ÷ (1.10) 3 = $ 0.7513 Sum $ 3.8092 P 0 = ( D 1 ÷ (1 + k ) 1 ) + … + ( D H ÷ (1 + k ) H ) + ( P H ÷ (1 + k ) H ) where P H = ( D H +1 ÷ ( k − g )) = ($2.00 ÷ (1.10) 1 ) + ($1.50 ÷ (1.10) 2 ) + ($1.00 ÷ (1.10) 3 ) + (($1.00 × (0.99)) ÷ (0.10 + 0.01)) ÷ (1.10) 3 ) = $10.57 References Multiple Choice Difficulty: 3 Challenge                  