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Practice Questions: Chapters 10-15: Common Stocks (Valuation and
Practice Questions: Chapters 10-15: Common Stocks (Valuation and
Practice Questions: Chapters 10-15: Common Stocks (Valuation and
2.
3.
4.
5.
Using the constant growth version of the DDM to determine the intrinsic value of a
stock
a.
the formula calls for the dividend to be paid this period
b.
the required rate of return is expected to be larger than the growth rate in
dividends
c.
there is no present value process involved in the simple equation used in this case
d.
the answer obtained from this equation is the definitive value for the stock for all
investors
6.
7.
Sardi Company currently earns $3.00 per share and currently pays $1.20 per share in
dividends. It is expected to have a constant growth rate of 7% per year. The required
rate of return is 14%. The stock price is
a.
$42.86
b.
$18.34
c.
$17.14
d.
$40.05
8.
Johnson stock is currently selling for $40. The expected dividend is $2. This is a constant
growth firm. If investors require a return of 15% on this stock, what do they think the
growth rate will be?
a.
6%
b.
7%
c.
8%
d.
11%
e.
none of the above
9.
Calculate the estimated price of the following stock. Required rate of return: 15%;
Expected dividend next year: $20
Expected constant growth rate of dividends: 10%
a.
4
b.
400
c.
440
d.
none of the above
10.
BLC Industries is expected to pay a dividend of $1.50, and the dividend is expected to
grow at a constant rate of 7%. This stock is 15% less risky than the market as a whole.
The risk-free rate is 6%, and the equity risk premium for the market is 8%. The
estimated price of the stock is
a.
$18.75
b.
$21.43
c.
$27.76
d.
$25.86
11.
Your required rate of return is 15%. Z Corp. is currently selling for $40 and the most
recent dividend paid was $2.55. The expected constant growth rate is 8%. What is the
maximum you should pay for this stock?
a.
$39.29
b.
$40
c.
$36.43
d.
none of the above
12.
Percy Pondscum & Company currently earns $3.00 per share and currently pays $1.20
per share in dividends. It is expected to have a constant growth rate of 7% per year. The
risk free rate of return is 6%, the market risk premium is 8%, and the beta for this
company is 1.0. The stock price is
a.
$42.86
b.
$18.34
c.
$17.14
d.
$40.05
e.
none of the above
13.
Xila expects to earn $4.00 per share next year, with an expected payout of 30%.
Investors expect the dividend to grow at a constant rate of 8% for the foreseeable future.
The risk-free rate is 5%, and the beta that is 10% more volatile than the market as a
whole, and the expected return on the market is 14%. What is the estimated price of the
stock?
a.
$12.12
b.
$50
c.
$13.33
d.
none of the above
14.
Johnsey Industries' current dividend is $2. The average growth rate for the past many
years has been steady at 8%, but the consensus of analysts is that the expected growth
rate is 6% . k = 16%. The intrinsic value of this stock is:
a.
$20
b.
$18.80
c.
$9.09
d.
$21.20
15.
Jack buys Wealth Enterprises for $40. He expects the firm's earnings and dividends to
grow at an annual rate of 7%. The firm expects to pay a dividend of $2.00 next year.
The market risk premium is 8%. Jack's expected rate of return is
a.
10%
b.
12%
c.
12.35%
d.
15%
16.
Walter Company currently earns $3.00 per share and pays $1.00 in dividends. The
dividend is expected to double in 9 years and also to grow at that rate beyond that time.
The required rate of return is 15%. The estimated stock price is
a.
$15.42
b.
$6.66
c.
$14.29
d.
none of the above
17.
Your required rate of return is 15.1%. Davis Drives is currently selling for $38 per share
and is expected to pay a dividend of $3 next period. The expected constant growth rate is
7%. Which of the following statements is true in making a stock decision?
a.
you can justify buying this stock because: expected return > the required return
b.
you cannot justify buying this stock because: the required return > the expected
return
c.
you cannot justify buying this stock because: the required return < the expected
return
d.
you can justify buying this stock because: the required return > than the expected
return
18.
Investor A and investor B both have required rates of return of 12%. They are
considering the purchase of XTRA stock, which each views as a constant growth case.
Both have estimated the dividend for the next period at $1.00, and both agree that the
expected growth rate in dividends will be 6% a year. However, investor A plans to buy
the stock and hold it for 10 years, while investor B plans to buy the stock and hold it for
ONLY 1 year. Which of the following statements is CORRECT about stock valuation?
a.
Investor A should be willing to pay more for this stock than B.
b.
Investor B should be willing to pay more for this stock than A.
c.
Both investors should be willing to pay the same price for the stock.
d.
None of these.
19.
Using the constant growth model, an increase in the required rate of return from 15 to
16%, combined with an increase in the growth rate from 7 to 8%, would cause the price
of a constant growth stock, to: (assume the next dividend is $2.00)
a.
increase in price
b.
decrease in price
c.
stay the same
d.
not enough information to answer the question
20.
Low Labs. last dividend was $1.50. Its current equilibrium stock price is $15.75, and its
expected growth rate is a constant 5 percent. If the stockholders' required rate of return is
15 percent, what is the expected dividend yield and expected capital gains yield for the
coming year?
a.
0%; 15%
b.
5%; 10%
c.
10%; 5%
d.
15%; 0%
21.
The Smith Reclamation Company has been hit hard due to increased competition. The
companys analysts predict that earnings (and dividends) will decline at a rate of 5
percent annually from now on. k = 14% and D0 = $2.00. What will be the estimated
price of the companys stock four years from now (this will be the price at the
beginning of year 5)? Round all calculations to two places.
a.
$27.17
b.
$11.11
c.
$28.50
d.
$10.18
e.
$8.16
22.
A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50,
$2.00, and $3.50. If growth is then expected to level off at 8 percent, and if you require a
14 percent rate of return, what is the estimated price of this stock? Round calculations
to two places.
a.
$67.81
b.
$22.49
c.
$58.15
d.
$31.00
e.
none of the above
23.
Find the estimated price of Robot Communications if the expected growth rate in
dividends is 14% for the next three years, after which the dividend is expected to slow
down and grow at a rate of 6%. The current dividend is $2.00 per share, and the required
rate of return is 18%. Round calculations to two decimal places.
a.
$31.77
b.
$26.17
c.
$21.52
d.
$15.94
24.
ABC Company has been growing at a 10% rate, and it just paid a dividend of D0 = $3.00.
Due to a new product, ABC expects to achieve a dramatic increase in its short-run growth
rate, to 20% annually for the next 2 years, after which growth is expected to return to the
long-run constant rate of 10 percent. The companys beta is 2.0, the required return on an
average stock is 11 percent, and the risk-free rate is 7 percent. Calculate the expected
dividend yield, D1/P0. Round calculations to two places.
a.
3.93%
b.
4.58%
c.
10.00%
d.
7.54%
25.
26.
27.
ABC corp. expects to earn $4.00 per share next year, and pay $3.00 per share in
dividends. Expected growth rate in dividends is 6%, required rate of return is 16%. The
P/E ratio is
a.
6
b.
10
c.
7.5
d.
5
28.
X Corp. retains 70% of its earnings in the business. The long-run earnings growth is
expected to be 10%. The risk-free rate is 8%, the expected return on the market is 12%,
the beta is 2.0, and the most recent dividend was $1.50. What are the most likely market
price and P/E for this stock today?
a.
$27.50, 5x
b.
$33, 6x
c.
$25, 5x
d.
$22.50, 4.5x
e.
$45, 4.5x
CHAPTER 11:
30.
31.
The INCORRECT statement involving the required rate of return for a stock is:
a.
it equals the risk-free rate plus the market risk premium
b.
ex ante, it must slope upward
c.
the overall level of required rates of return changes as the risk premiums change
d.
it is the minimum expected rate of return needed to induce an investor to purchase
a security
32.
33.
Sector rotation is
a.
one form of passive investing
b.
an active strategy similar to stock selection
c.
an attempt to earn excess returns by varying the percentage of portfolio assets in
equity securities
d.
not dependent on an accurate assessment of current economic conditions
34.
35.
Fundamental analysts assume that the market price and intrinsic value of a stock
a.
are always identical
b.
can differ from time to time
c.
bear no relationship to each other
d.
none of these
36.
37.
38.
39.
CHAPTER 12:
40.
41.
42.
The semi-strong form of the efficient market hypothesis asserts that stock prices:
a.
fully reflect all historical price information.
b.
fully reflect all publicly available information.
c.
fully reflect all relevant information including insider information.
d.
may be predictable.
43.
44.
45.
46.
47.
48.
With regard to the efficient market hypothesis, choose the INCORRECT statement.
a.
The strong form of the EMH incorporates the other two forms
b.
Technical analysis and the weak form of the EMH are direct opposites
c.
The anomalies were apparent exceptions to market efficiency, and all have now
been refuted
d.
Stock prices can have some degree of statistical dependence while being
economically independent
49.
Which of the following portfolio management tasks do not have to be performed if the
market is efficient?
a.
minimization of transaction costs
b.
ensuring the proper amount of diversification
c.
adjusting the asset allocation percentages based on perceived changes in
economic conditions
d.
achieving a level of risk appropriate for the portfolio
50.
51.
CHAPTER 13:
52.
53.
54.
55.
The dividend payout ratio on the S&P 100 is 40% when RF = 9%. Investors demand an
equity risk premium of 8 percent. If the growth rate of dividends is expected to be 10
percent, what is the estimated price of the market index if the earnings expectation is
$30?
a.
$384.00
b.
$213.44
c.
$266.56
d.
$171.43
56.
57.
58.
In using the business cycle to make market forecasts, which of the following statements
is INCORRECT?
a.
it is particularly important to switch into stocks before business cycle troughs
b.
as the economy recovers, stock prices may level off or even decline
c.
based on the last 10 economic slumps, the market P/E usually falls just before the
end of the slump
d.
if the investor can recognize the bottoming out of the economy before it occurs, a
market rise can be predicted, at least based on past experience, before the
bottom
is hit
59.
60.
Which of the following statements is INCORRECT about the market and the
economy?
a.
Stock prices generally lead the economy
b.
The market has given false signals, particularly with regard to recessions.
c.
The market almost always rises before a recessions trough
d.
Typically, as investors recognize what the economy is doing, the stock market
also recognizes the event and reacts to it
61.
CHAPTER 14:
62.
In which stage of the industry life cycle do firms often offer stability in earnings and
dividend growth?
a.
pioneering stage
b.
expansion stage
c.
stabilization stage
d.
in all three stages equally
63.
What stage of the industry life cycle is likely to be of most interest to the majority of
investors?
a.
pioneering stage
b.
expansion stage
c.
maturity stage
d.
declining stage
64.
During the maturity stage of the industry life cycle, companies often tend to pay high
dividends because of
a.
high capital gains
b.
small risk
c.
few growth opportunities
d.
good stability
65.
Based on the industry life cycle, investor risk is the highest during the
a.
pioneering stage.
b.
expansion stage.
c.
stabilization stage.
d.
declining stage.
66. Which of the following statements about the industry life cycle is INCORRECT?
a.
All industries can be classified very accurately into a specific phase of the life
cycle.
b.
Companies may not always fit into a particular stage of the life cycle.
c.
Even the general framework may not apply to some industries.
d.
It does not explicitly lead to stock price determination.
67.
68.
69.
Which of the following in not one of the five competitive forces of Porter?
a.
structural changes in the economy
b.
bargaining power of buyers
c.
threat of substitute products or services
d.
threat of new entrants
The most important point of Michael Porters analysis is that industry profitability is a
function of the
a.
economy.
b.
interest-rate level.
c.
industry structure.
d.
industry beta.
70.
71.
72.
In which source of industry information can you find a ranking of industries in terms of
timeliness?
a.
Forbes
b.
Value Line Investment Survey
c.
Standard and Poors Industry Survey
d.
Robert Morris Associates Annual Studies
73.
Investors who are interested primarily in capital gains should avoid industries that are in
the __stage because they have ______.
a.
stabilization stage; low dividend payouts
b.
stabilization stage; high dividend payouts and low growth prospects
c.
pioneering; low dividend payouts
d.
expansion stage; high risk
CHAPTER 15:
74.
75.
76.
The cash flow statement is designed to track the flow of cash through the firm and
consists of three parts. Which of the following is not one of the designated parts?
a.
cash from operating activities
b.
cash from spending activities
c.
cash from financing activities
d.
cash from investing activities
77.
ROA
a.
b.
c.
d.
Find ROA
a.
0.30
b.
0.10
c.
0.15
d.
0.225
79.
Find ROE
a.
.225
b.
.3375
c.
.15
d.
.45
80.
If a firms ROA and ROE are equal, it can be concluded that the firm is
a.
losing money.
b.
liquid enough to pay some extra dividends.
c.
financed by all equity.
d.
financed by a high proportion of debt
81.
82.
Assume ROA is 18.45%, the leverage factor is 2.278, and the BV ps is $3.41. The EPS
will be
a.
$.63
b.
$1.43
c.
$.42
d.
none of the above
83.
Bilbro Co., has a book value of $10, pays a current dividend of $1, has an ROE of .10, an
ROA of .05, a leverage ratio of 2, and a profit margin of 15%. Its EPS are
a.
$3
b.
$2
c.
$1.50
d.
none of the above
84.
Calculate the expected growth rate, g, of a firm which has a current dividend of $1.50
and a ROE of 20%.
a.
20%
b.
10%
c.
40%
d.
answer cannot be calculated from this information.
85.
86.
87.
88.
89.
You are considering a stock with a current market price of $20. The stock's last dividend
was $2.00, and earnings and dividends are expected to increase at a constant growth rate
of 10 percent. Your required return on this stock is 20 percent. From the standpoint of
making a valuation decision, you should:
a.
Not buy the stock; it is overvalued by $3.00.
b.
Buy the stock; it is undervalued by $3.00.
c.
Buy the stock; it is undervalued by $2.00.
d.
Not buy the stock; it is overvalued by $3.00.
90.
91.
92.
Given the SUE's of 4 different stocks, which has the greatest unexpected earnings?
a.
-3.5
b.
-2.5
c.
2.0
d.
3.0
93.
Other things equal, concerning k, the discount rate for stocks, we can say
a.
as k rises, the P/E ratio rises
b.
if the risk premium rises, k will fall
c.
if the risk-free rate rises, k will rise
d.
discount rates and P/E ratios move directly with each other
94.
95.
Other things equal, concerning the P/E ratio, we can say that if
a.
required rate of return increases, the P/E ratio will rise.
b.
risk premium increases, the P/E ratio will rise.
c.
risk-free rate rises, the P/E ratio will fall.
d.
dividend payout increases, the P/E ratio will fall.
96.
How would you explain P/E ratio differences among companies? By investor
a.
expectations about the future growth of the market.
b.
estimates of the recent growth of earnings.
c.
expectations about the future growth of earnings.
d.
estimates about the recent growth of dividends.
97.
98.
A P/E ratio
a.
can only be calculated based on the prior 12-month earnings
b.
can be calculated using prior earnings or estimated earnings
c.
for the market as a whole is not likely to change much from one year to the next
d.
can be calculated for every company every year
99.
100.
Wibex is expected to earn $4.00 next year, and pay $2.00 per share in dividends. The
expected growth rate in dividends is 6% and required rate of return is 16%. Calculate
the P/E ratio.
a.
6
b.
10
c.
50
d.
5