CORPORATE FINANCE

__ProbSet__

__Chapter 7 (13ed.) – Stock Valuation__

1. A stock expects to pay a year-end dividend of

$2.00 a share. Last year’s dividend has

already been paid. The dividend is

expected to fall 5 percent a year, forever.

The company’s expected and required rate of return is 15%. Which of the following statements is most

correct?

a.

The company’s stock price is $10.

b.

The company’s expected dividend yield 5 years from now will be 20

percent.

c.

The company’s stock price 5 years from now is expected to be $7.74.

d.

Both answers b and c are correct.

e.

All of the above answers are correct.

2. The relationship

between a stock’s required and expected rates of return determines the

security’s

equilibrium price level. Which of the

following is true?

- At

this equilibrium level, a stock’s required return will equal a bond’s

coupon. - If the

expected rate of return is less than the required rate, investors will

desire to buy

the stock and there will be a

tendency for the price to rise.

c. If the expected rate of return is greater

than the required rate, investors will try to

purchase shares of the stock, which

will drive the price up.

d. If the expected rate of return is less than

the required rate, investors will desire to sell

the stock and there will be a

tendency for the price to rise.

- Both

statement c and d are correct.

3. Which of the

following statements regarding constant growth stock valuation is

most correct?

a. Assume that the required rate of return on a

given stock is 12%. If the stock’s

dividend is growing at a constant

rate of 4%, its expected dividend yield is 4% as well.

b.

The expected capital gain yield on a stock is equal to the expected

return less

the dividend yield.

- A

stock’s dividend yield must at least equal the expected growth rate. - All of

the answers above are correct. - Answers

b and c are correct.

4. Which of the

following factors in the discounted cash flow (DCF) approach to

estimating the

cost of common equity is the *least*difficult

to estimate?

- Expected

growth rate, g. - Dividend

yield, D1/Po. - Required

return, Ks. - Expected

rate of return, K_{s} - All of

the above are equally difficult to estimate.

5. A stock is not

expected to pay a dividend over the next four years. Five years from now,

the company

anticipates that it will establish a dividend of $1.00 per share. Once the

dividend is

established, the market expects that the dividend will grow at constant rate of

5

percent per year

forever. The risk-free rate is 5

percent, the company’s beta is 1.2, and

the market risk

premium is 5 percent. The required rate

of return on the company’s stock is

expected

to remain constant. What is the current

stock price?

a. $7.36

b. $8.62

c. $9.89

d. $10.98

e. $11.53

6. ABC Company has

been growing at a 10 percent rate, and it just paid a dividend of Do = .

$3.00. Due to a new product, ABC expect to achieve a

dramatic increase in its short-run growth rate, to 20 percent annually for the

next 2 years. After this time, growth is

expected to return to the long-run constant rate of 10 percent. The company’s beta is 2.0, the required return

on an average stock is 11 percent, and the risk-free rate is 7 percent. What should the dividend yield be today?

a. 3.93%

b. 4.60%

c. 10.00%

d. 7.54%

e. 2.33%

7. Albright Motors is

expected to pay a year-end dividend of $3.00 a share.

The stock

currently sells for $30 a share. The

required (and expected) rate of return

on the stock is

16%. If the dividend is expected to grow

at a constant rate, g, what is g?

- 13.00%
- 10.05%
- 6.00%
- 5.33%
- 7.00%

8. Cartwright

Brothers’ stock is currently selling for $40. a share. The stock is expected to

pay a $2.

dividend at the end of the year. The stock’s dividend is expected to grow at a

constant rate of

7 percent a year forever. The risk-free

rate is 6 percent and the market

risk premium is

also 6 percent. What is the stock’s

beta?

a. 1.06

b. 1.00

c. 2.00

d. 0.83

e. 1.08

9. Over

the past few years, Swanson Company has retained, on the average, 70 percent of

its earnings in the business. The future

retention rate is expected to remain at 70 percent of earnings, and long-run

earnings growth is expected to be 10 percent.

If the risk-free rate is 8 percent, the expected return on the market,

is 12 percent, Swanson’s beta is 2.0, and the most recent dividend, D_{0},

was $1.50, what is the most likely market price and P/E ratio (P_{0}/E_{1})

for Swanson’s stock today?

a. $27.50; 5.0x

b. $33.00; 6.0x

c. $25.00; 5.0x

d. $22.50; 4.5x

e. $45.00; 4.5x

10. Chadmark

Corporation is expanding rapidly, and it currently needs to retain all of its

earnings, hence it does not pay any dividends.

However, investors expect Chadmark to begin paying dividends with the

first dividend of $0.75 coming 2 years from today. The dividend should grow at a constant rate

of 10 percent per year. If the required

return on the stock is 16 percent, what is the value of the stock today?

11. HBT

Corporation has never paid a dividend.

Its current free cash flow is $1,200,000 and is expected to grow at a

constant rate of 4%. The overall cost of

capital is 10%. What is HBT’ value of

operations (in millions)?

12. Assume that

as investment manager of Maine Electric Company’s pension plan (which is exempt

from income taxes), you must choose between Exxon bonds and GM preferred

stock. The bonds have a $1,000 par

value; they mature in 20 years; they have a 7% stated interest rate paid

semi-annually; they are callable at Exxon’s option at a price of $1,150 after 5

years, and they sell at a price of $815.98 per bond. The Preferred stock is perpetuity: it pays a

dividend of $1.50 each quarter, and it sells for $75 per share. Assume interest rates do not change. What is the most likely effective annual

rate of return on the higher yielding security?

13. Assume an all equity firm has

been growing at a 15 percent annual rate and is expected to continue to do so

for 3 more years. At that time, growth

is expected to slow to a constant 4 percent rate. The firm maintains a 30 percent payout ratio,

and this year’s retained earnings net of dividends were $1.4 million. The firm’s beta is 1.25, the risk-free rate

is 8 percent, and the market risk premium is 4 percent. If the market is in equilibrium, what is the

market value of the firm’s common equity (1 million shares outstanding)?

14. Dozier Corp

is a fast growing supplier of office products.

Analysts project the following free cash flows (FCFs) during the next

three years, after which FCF is expected to grow at a constant 7% rate. Dozier’s cost of capital is 13%.

Time 1 2 3

Free cash

Flow ($mill) -$20 $30 $40

a. What

is Dozier’s terminal, or horizon value?

b. Suppose

Dozier has $10 million in marketable securities, $100 million in debt, and 10

million shares of stock. What is the

price per share?

What is the current value of the operations