Extra practice exercies

1. A stock paying $5 in annual dividends sells now for $80 and has an expected return of
14%. What might investors expect to pay for the stock one year from now?
A) $82.20
B) $86.20
C) $87.20
D) $91.20

Answer: B Difficulty: Medium Page: 139, 1st paragraph.

Div1  P1  Po
Expected return =
Po
$5  P1 $80
14% =
$80
$11.20 = P1 – $75
$86.20 = P1

2. What should be the price for a common stock paying $3.50 annually in dividends if the
growth rate is zero and the discount rate is 8%?
A) $22.86
B) $28.00
C) $42.00
D) $43.75

Answer: D Difficulty: Medium Page: 144, 1st paragraph.

Div 3.50
Po =   $43.75
r .08

3. What constant growth rate in dividends is expected for a stock valued at $32.00 if next
year’s dividend is forecast at $2.00 and the appropriate discount rate is 13%?
A) 5.00%
B) 6.25%
C) 6.75%
D) 15.38%

Answer: C Difficulty: Medium Page: 145, 1st paragraph.

2.00
$32.00 = .13  g
$4.16 – 32g = $2.00
$2.16 = 32 g
.0675 = g
6.75% = g

4. If next year’s dividend is forecast to be $5.00, the constant growth rate is 4%, and the
discount rate is 16%, then the current stock price should be:
A) $31.25
B) $40.00
C) $41.67
D) $43.33

Answer: D Difficulty: Medium Page: 145, 1st paragraph.

 $5.00
Po =
.16.04
$5.00
$41.67 =
.12

5. ABC common stock is expected to have extraordinary growth of 20% per year for two
years, at which time the growth rate will settle into a constant 6%. If the discount rate
is 15% and the most recent dividend was $2.50, what should be the current share
price?
A) $31.16
B) $33.23
C) $37.42
D) $47.77

Answer: C Difficulty: Hard Page: 148, 2nd paragraph.

$2.50(1.2) $2.50(1.2)2 2.50(1.2)2 (1.06)
Po =  
1.15 1.15 2 (.15 .06)(1.15)2
$3.00 $3.60 $3.82
=  
1.15 1.3225 .09(1.3225)
= $2.61 + 2.72 + 32.09
= $37.42

6. What is the plowback ratio for a firm that has earnings per share of $12.00 and pays
out $4.00 per share as dividends?
A) 25.00%
B) 33.33%
C) 66.67%
D) 75.00%
Answer: C Difficulty: Medium Page: 149, 4th paragraph.
plowback = 1 - payout ratio
$4.00
=1–
$12.00
= 1 – .33
» .67

7.What price would you expect to pay for a stock with 13% required rate of return, 4% rate of
dividend growth, and an annual dividend of $2.50 which will be paid tomorrow?
A) $27.78
B) $30.28
C) $31.10
D) $31.39

Answer: D Difficulty: Hard Page: 145, 1st paragraph.

 D1
Po = Do +
kg
$2.50(1.04)
= $2.50 +
.13.04
$2.60
= $2.50 +
.09
= $2.50 + $28.89
= $31.39

8.What rate of return is expected from a stock that sells for $30 per share, pays $1.50
annually in dividends, and is expected to sell for $33 per share in one year?
A) 5.00%
B) 10.00%
C) 14.09%
D) 15.00%

Answer: D Difficulty: Medium Page: 145, 1st paragraph.

DIV P1  Po
Expected Return = 
Po Po
1.50 33.00  30.00
= 
30.00 30.00
= .05 + .10
= .15 = 15%
Sample midterm 1

.
14. The net present value formula for one period is:
A) NPV = PV cash flows/initial investment
B) NPV = C0/C1
C) NPV = C0+[C1/(1 + r)]
D) Any of the above
E) None of the above

Answer: C

This is the NPV formula for a project which produces one piece of cash flow in the
next period.

15. The managers of a firm are supposed to

A) take all projects with positive NPVs

B) take all projects with NPVs greater than the discount rate
C) take all projects with NPVs greater than present value of cash flow
D) All of the above
E) None of the above

Answer: A

16. What is the net present value of the following cash flows at a discount rate on 12%?
 t = 0 t = 1 t= 2 t= 3
- 2 5 0 ,0 0 0 1 0 0 ,0 0 0 1 5 0 ,0 0 0 2 0 0 ,0 0 0

A) $101,221
B) $200,000
C) $142,208
D) None of the above

Answer: A
NPV = -250,000 + (100,000/1.12) + (150,000/(1.12^2)) + 200,000/(1.12^3) = 101,221

17. You would like to have enough money saved to receive a perpetuity, with the first payment
being $60,000, after retirement so that you and your family can lead a good life. How much
would you need to save in your retirement fund to achieve this goal (assume that the
perpetuity payments start one year from the date of your retirement. The interest rate is 10%)?
A) $7,500,000
B) $1,500,000
C) $600,000
D) None of the above

Answer: C
After your retirement, you will receive a standard perpetuity.

PV = 60,000/0.1 = 600,000

18. Three yeas from now, if the economy is good, you will receive $100; if the economy is
bad, you will receive $50. If the probability for the good economy is 30% and the economy
has only two states three years from now: good and bad, what is the present value of this
expected payment if the discount rate is 3.5%?
A) $65.00
B) $72.07
C) $59.48
D) None of the above
E) Any of the above

Answer : D

First calculate C3, which is the expected cash flows at period three.

C3 = 0.3*100+0.7*50=$65
PV= C3/(1+r)3 = 65/1.0353 = $58.63

19. 10 years from now, you will receive a payment, which is 1.5 times the present value
of this payment? If the discount rate is the same for every year, what is the annual
discount rate ?
A) 8.10%
B) 8.18%
C) 7.18%
D) 4.14%
E) none of the above

Answer D.

Let the present value be $1. The future value will be $1.5. Then, we have
1=1.5/(1+r)10. Then (1+r)10=1.5. r = (1.5)1/10 -1 = 4.14%.

20. You have a car loan of $30,000 (which is called the principle) with the interest rate of
6.5%. You decide to pay off this loan in next four years with equal payment each
year, what is the remaining principal before the last payment?
A) $7,621.03
B) $8,757.08
C) $9,523.36
D) $ 8,222.61
E) none of the above

First use the annuity formula to calculate the total payment in each period.

That is, 30000=C(1/r-1/(r.(1+r)4)), where r=0.065. So C=$8,757

Let the remaining principal be x before the last payment. Then, the interest payment in the
last period is 0.065x. Since principal + interest payment = total payment, we have
x + 0.065x =C=8757. x = 8757/(1+0.065)=$8,222.61

Answer: D.

21.The annual coupon rate of a bond equals:

A) its yield to maturity.
B) a percentage of its price.
C) the maturity value.
D) the ratio of the annual coupon payment to the par value.
E) None of the above

Answer: D

22.The face value of a bond is received by the bondholder:

A) at the time of purchase.
B) annually.
C) whenever coupon payments are made.
D) at maturity.
E) none of the above

Answer: D

23.Which of the following presents the correct relationship? As the coupon rate of a bond
decreases, the bond’s:
A) face value increases.
B) bond price tends to increase.
C) interest payments increase.
D) maturity date is extended.
E) coupon payments decrease

Answer: E

24. How much would an investor expect to pay for a $1,000 par value bond with a 9% annual
 coupon that matures in 5 years if the interest rate is 9%?
A) $696.74
B) $1,075.00
C) $1,000.00
D) $1,123.01
E) None of the above

Answer: C

25.The current yield of a bond can be calculated by:

A) multiplying the price by the coupon rate.
B) dividing the price by the annual coupon payments.
C) dividing the price by the par value.
D) dividing the annual coupon payments by the price.
E) none of the above

Answer: D

26. Which of the following statements is correct for a 10% coupon bond that has a current
yield of 13%?
A) The face value of the bond has decreased.
B) The discount rate is 13%.
C) The bond’s price is smaller than the bond’s maturity value (par value).
D) The bond has few years remaining until maturity.
E) None of the above

Answer: C

27.What is the coupon rate for a bond (par value of $1,000) with three years until maturity, a
price of $1,000, and a yield to maturity of 6%?
A) 6%
B) 7%
C) 8%
D) 9%
E) None of the above

Answer: A
 1 1  $1,000
$1,000 = PMT   3  3
 .06 .06(1.06)  (1.06)
$60.00 = PMT
$60
 6% coupon rate. In fact you don’t need to calculate. Why?
1000

28.What happens to the price of a three-year bond with an 8% coupon when interest rates
change from 8% to 6%?
A) A price increase of $53.47
B) A price decrease of $51.54
C) A price decrease of $53.47
D) No change in price
E) None of the above
 Answer: A
 1 1  $1,000
PV = $80   3 
 3
 .06 .06i(1.06)  (1.06)
$1,000
= $80[16.667 – 13.994] +
1.06  3
= $213.84 + $839.63
= $1,053.47

This represents a price change of $53.47, since the bond had sold for par.

30.What is the rate of return for an investor who pays $1,054.47 for a three-year bond with a
7% coupon and sells the bond one year later for $1,037.19?
A) 5.00%
B) 5.33%
C) 6.46%
D) 7.00%
E) none of the above

Answer: A
Rate of Return = ($70.00 - $17.28)/$1,054.47
= $52.72/$1,054.47
= 5%

31.According to the dividend discount model, the current value of a stock is equal to the:
A) present value of all expected future dividends.
B) sum of all future expected dividends.
C) next expected dividend, discounted to the present.
D) discounted value of all dividends growing at a constant rate.
E) none of the above

Answer: A

32.If a stock’s P/E ratio is 13.5 at a time when earnings are $3 per year, what is the stock’s
current price?
A) $4.50
B) $18.00
C) $22.22
D) $40.50
E) None of the above

Answer: D
P/E = 13.5
Then P = 13.5 x $3
Price = $40.50

33. A stock paying $5 in annual dividends sells now for $100 and has an expected return of
20%. What might investors expect to pay for the stock one year from now?
A) $182.00
B) $186.00
C) $115.00
D) $110.00
E) None of the above
 Answer: C .

Div1  P1  Po
Expected return =
Po
$5  P1 $100
20% =
$100
$115 = P1

34.How much should you pay for a share of stock that offers a constant dividend growth rate
of 10%, has a discount rate of 16%, and pays a dividend of $3 next year?
A) $42.00
B) $45.00
C) $45.45
D) $50.00
E) none of the above

Answer: D

P0=C1/(r-g)=3/0.06=$50

35.The price of a stock will likely increase if:

A) the investment horizon decreases.
B) the growth rate of dividends increases.
C) the discount rate increases.
D) dividends are discounted back to the present.
E) none of the above

Answer: B

36.What should be the price for a common stock paying $3.50 annually in dividends if the
growth rate is zero and the discount rate is 8%?
A) $22.86
B) $28.00
C) $42.00
D) $43.75
E) None of the above

Answer: D
Div 3.50
Po =   $43.75
r .08
38.What is the expected constant growth rate of dividends for a stock currently priced at $50,
that is expected to pay a dividend of $5 next year, and has a required return of 20%?
A) 13%
B) 10%
C) 11%
D) 12%
E) none of the above

Answer: B
By using the dividend growth model, P0 =div1/(r-g), we have
$50 = $5/(.2 – g).
g = 0.1=10%

39.If the (current) dividend yield is 5% and the stock price is $25, what will the year three
dividend be if dividends grow at a constant 6%?
A) $1.33
B) $1.40
C) $1.58
D) $1.67
E) none of the above

Answer: B
Dividend yield is Div1/P0, which is 5%. So
Div1=.05 x 25 = 1.25
then, Div3 = div1*(1+g)2=1.25 x (1.06)2 = $1.4045

40.What would be the current price of a stock when dividends are expected to grow at a 25%
rate for three years, then grow at a constant rate of 5%, if the stock’s required return is 13%
and next year’s dividend will be $4.00?
A) $61.60
B) $62.08
C) $68.62
D) $79.44
E) None of the above

Answer: C

The idea to solve this problem is to assume that you hold the stock for three years and sell
the stock at the end of year 3. After year 3, the dividends have a constant growth rate
of 5%. By observing this constant growth rate of dividends, you can use the dividend
growth model to calculate the stock price at year 3, which is P3=Div4/(r-g), where
r=13% and g =5%.

Then the current stock price is the present value of three dividends received in each year in
the next three years, and the stock price at year 3.
 $4.00 $4.00(1.25) $4.00(1.25)2 $4.00(1.25)2 (1.05)
  
Po = (1.13) (1.13)2 (1.13)3 .13 .05
(1.13)3
$5.00 $6.25 6.56
 
= 3.54 + 1.2769 1.4429 .08
1.4429
= 3.54 + 3.92 + 4.33 + 56.83
= $68.62