Foundations of
Financial Management (10248) – Fall I, 2013
Week 6 Questions/Problems
Brushy
Mountain Mining Company’s ore reserves are being depleted, so its sales are
falling. Also, its pit is getting deeper each year, so its costs are rising. As
a result, the company’s earnings and dividends are declining at the constant
rate of 4% per year. If D_{0}=
$6 and r_{s}= 18%, what
is the value of Brushy Mountain Mining’s stock? Round your answer to the
nearest cent.
Problem 74
Preferred Stock Valuation
Nick’s Enchiladas Incorporated has preferred stock outstanding
that pays a dividend of $3 at the end of each year. The preferred stock sells
for $40 a share. What is the stock’s required rate of return? Round the answer
to two decimal places.
Problem 72
Constant Growth Valuation
·
eBook
·
Boehm Incorporated is expected to pay a $3.40 per share dividend
at the end of this year (i.e., D_{1}=
$3.40). The dividend is expected to grow at a constant rate of 10% a year. The
required rate of return on the stock, r_{s}, is 17%. What is the value
per share of the company’s stock? Round your answer to the nearest cent.
Q
Which of the following statements is CORRECT?









Q
If in the opinion of a given investor a stock’s expected returnexceedsits
required return, this suggests that the investor thinks









Companies can issue different
classes of common stock. Which of the following statements concerning stock
classes is CORRECT?







Which of the following statements is CORRECT, assuming stocks
are in equilibrium?









A share of common stock just paid a dividend of $1.00. If the
expected longrun growth rate for this stock is 5.4%, and if investors’
required rate of return is 11.4%, what is the stock price?









Problem 75
Nonconstant Growth Valuation
A company currently pays a dividend of $3.25 per share, D_{0}= 3.25. It is estimated that the company’s dividend will grow at
a rate of 23% percent per year for the next 2 years, then the dividend will
grow at a constant rate of 6% thereafter. The company’s stock has a beta equal
to 1.55, the riskfree rate is 7.5 percent, and the market risk premium is 6
percent. What is your estimate is the stock’s current price? Round your answer
to the nearest cent.
$
·
Check My Work(3
remaining)
A stock is expected to pay a yearend dividend of $2.00, i.e., D_{1}= $2.00. The dividend is expected to decline at a rate of 5% a
year forever (g =5%). If
the company is in equilibrium and its expected and required rate of return is
15%, which of the following statements is CORRECT?









Problem 710
Rates of Return and Equilibrium
·
eBook
·
The beta
coefficient for Stock C is b_{C}= 0.6, and that for
Stock D is b_{D}= – 0.6. (Stock D’s beta is negative,
indicating that its rate of return rises whenever returns on most other stocks
fall. There are very few negativebeta stocks, although collection agency and
gold mining stocks are sometimes cited as examples.)
a. If the riskfree rate
is 8%and the expected rate of return on an average stock is 11%, what are the
required rates of return on Stocks C and D? Round the answers to two decimal
places.
1. r_{C}=?
2. r_{D}=?
b. For Stock C, suppose
the current price, P_{0}, is $25; the next expected dividend, D_{1},
is $1.50; and the stock’s expected constant growth rate is 4%. Is the stock in
equilibrium? Explain, and describe what would happen if the stock is not in
equilibrium.
I.In this situation, the expected rate of return = 9.80%. However,
the required rate of return is 10%. Investors will seek to buy the stock,
raising its price to $25.86. At this price, the stock will be in equilibrium.
II.In this situation, the expected rate
of return = 10%. However, the required rate of return is 9.80%. Investors will
seek to sell the stock, raising its price to $25.86. At this price, the stock
will be in equilibrium.
III.In this situation, the expected rate
of return = 9.80%. However, the required rate of return is 10%. Investors will
seek to sell the stock, raising its price to $25.86. At this price, the stock
will be in equilibrium.
IV.In this situation, the expected rate
of return = 10%. However, the required rate of return is 9.80%. Investors will
seek to buy the stock, raising its price to $25.86. At this price, the stock
will be in equilibrium.
V.In this situation, both the expected
rate of return and the required rate of return are equal. Therefore, the stock
is in equilibrium at its current price.
For a stock to be in equilibrium,
that is, for there to be no longterm pressure for its price to depart from its
current level, then









Problem 715
Constant Growth Stock Valuation
·
eBook
·
Investors require a 15% rate of return on Brooks Sisters’ stock
(r_{s}= 15%).
a. What
would the value of Brooks’s stock be if the previous dividend was D_{0}= $3.25 and if investors expect dividends to grow at a constant
compound annual rate of (1) – 2%, (2) 0%, (3) 7%, or (4) 12%? Round your
answers to the nearest cent.
1. $
2. $
3. $
4. $
b. Using
data from part a, what is the Gordon (constant growth) model’s value for Brooks
Sisters’s stock if the required rate of return is 15% and the expected growth
rate is (1) 15% or (2) 23%? Are these reasonable results? Explain.
1.
2.
c. Is it
reasonable to expect that a constant growth stock would have g > r_{s}?
Problem 716
Equilibrium Stock Price
·
eBook
·
The riskfree rate of return, r_{RF}, is 11%; the required rate of return on the market, r_{M},
15%; and Schuler Company’s stock has a beta coefficient of 1.7.
a. If the
dividend expected during the coming year, D_{1}, is $2.00, and if g is
a constant 1.75%, then at what price should Schuler’s stock sell? Round your
answer to the nearest cent.
$
b. Now,
suppose the Federal Reserve Board increases the money supply, causing a fall in
the riskfree rate to 6% and r_{M}to 13%.
How would this affect the price of the stock? Round your answer to the nearest
cent.
$
c. In
addition to the change in part b, suppose investors’ risk aversion declines;
this fact, combined with the decline in r_{RF}, causes r_{M}to fall to 8%. At what price would Schuler’s stock sell? Round
your answer to the nearest cent.
$
d.
Suppose Schuler has a change in management. The new group
institutes policies that increase the expected constant growth rate to 7%.
Also, the new management stabilizes sales and profits, and thus causes the beta
coefficient to decline from 1.7 to 0.7. Assume that r_{RF}and r_{M}are equal
to the values in part c. After all these changes, what is Schuler’s new
equilibrium price? (Note:D_{1}goes to $2.10.) Round your answer to the nearest cent.
$
The expected return on Natter Corporation’s stock is 14%. The
stock’s dividend is expected to grow at a constant rate of 8%, and it currently
sells for $50 a share. Which of the following statements is CORRECT?








