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Chapter 05

The Value of Common Stocks

MultipleChoiceQuestions:

shareandthenbesoldfor\$115dollarspershare.Iftherequiredrateofreturn
forthestockis20%,whatisthecurrentvalueofthestock?
A.\$100
b.\$122
c.\$132
d.\$110

P=(115+5)/1.2=100

ofyear1,\$3pershareattheendofyear2andthenbesoldfor\$32pershare.
Iftherequiredrateonthestockis15%,whatisthecurrentvalueofthestock?
A.\$28.20
b.\$32.17
c.\$32.00

P0=(2/1.15)+[(3+32)/(1.15^2)]=\$28.20

(D1)andthesedividendsareexpectedtogrowataconstantrateof6%peryear
forever.Iftherequiredrateofreturnonthestockis18%,whatiscurrentvalue
ofthestocktoday?
A.\$25
b.\$50
c.\$100
d.\$54

P0=Div1/(rg)=(3/(0.180.06))=25
andthedividendsareexpectedtogrowataconstantrateof4%forever.Ifthe
currentpriceofthestockis\$20persharecalculatetheexpectedreturnorthe
costofequitycapitalforthefirm:
a.10%
b.4%
C.14%
d.Noneoftheabove
r=[(D1/P0)+g]=(2/20)+0.04=14%

forGE.(Approximately)
a.\$679billion
b.\$188billion
C.\$382billion
d.Noneoftheabove

Marketcapitalization=(10.3)(37.10)=\$382.13billion

6. A stock is expected to pay a dividend of \$0.75 at the end of the year. The required rate of
return is rs = 12.5%, and the expected constant growth rate is g = 8.5%. What is the
current stock price?

A. \$17.82
B. \$18.28
C. \$18.75
D. \$19.22
E. \$19.70

D1 \$0.75
rs 12.5%
g 8.5%
P0 = D1/(rs g) \$18.75

7. A stock just paid a dividend of D0 = \$1.75. The required rate of return is rs = 12.0%, and
the constant growth rate is g = 4.0%. What is the current stock price?

A. \$20.56
B. \$21.09
C. \$21.63
D. \$22.18
E. \$22.75

D0 \$1.75
rs 12.0%
g 4.0%
D1 = D0(1 + g) = \$1.82 Intermediate step used to find answer
P0 = D1/(rs g) \$22.75

longrungrowthrateforthisstockis5.0%,andifinvestors'requiredrateof
returnis10.5%,whatisthestockprice?

A. \$35.39

B. \$36.30

C. \$37.23

D. \$38.18

E. \$39.14

Last dividend (D0) \$2.00

Long-run growth rate 5.0%
Required return 10.5%
D1 = D0(1 + g) = \$2.10 Intermediate step used to find answer
P0 = D1/(rs g) \$38.18

9. Ewert Enterprises' stock currently sells for \$30.50 per share. The stocks dividend is
projected to increase at a constant rate of 4.50% per year. The required rate of return on
the stock, rs, is 10.00%. What is Ewert's expected price 3 years from today?
a. \$31.61
b. \$32.43
c. \$33.26
d. \$34.11
e. \$34.81

Stock price \$30.50

Growth rate 4.50%
Years in the future 3
P3 = P0(1 + g)3 = \$34.81

10. E. M. Roussakis Inc.'s stock currently sells for \$45 per share. The stocks dividend is projected
constant rate of 3.75% per year. The required rate of return on the stock, rs, is 15.50%. What is R
expected price 5 years from now?

A. \$48.88
B. \$50.14
C. \$51.42
D. \$52.74
E . \$54.09

Growth rate 3.75%

Years in the future 5
Stock price \$45.00
P5 = P0(1 + g)5 = \$54.09

11.The Isberg Company just paid a dividend of \$0.80 per share, and that dividend is expected to
grow at a constant rate of 6.00% per year in the future. The company's beta is 1.25, the
market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current
stock price?

A. \$19.95
B. \$20.45
C. \$20.96
D. \$21.49
E. \$22.02

Constant growth valuation: CAPM Answer: a

D0 \$0.80
b 1.25
rRF 4.0%
RPM 5.0%
g 6.0%
D1 = D0(1 + g) = \$0.85 Intermediate step
rs = rRF + b(RPM) = 10.3% Intermediate step
P0 = D1/(rs g) \$19.95

12.Schnusenberg Corporation just paid a dividend of \$0.65 per share, and that dividend is
expected to grow at a constant rate of 7.00% per year in the future. The company's beta is
0.95, the required return on the market is 10.50%, and the risk-free rate is 5.00%. What is
the company's current stock price?

A. \$21.57
B. \$22.11
C. \$22.66
D. \$23.22
E. \$23.80
Constant growth valuation: CAPM Answer: a

D0 \$0.65
b 0.95
rRF 5.0%
rM 10.5%
g 7.0%
D1 = D0(1 + g) = \$0.70 Intermediate step
rs = rRF + b(rM RRF) = 10.2% Intermediate step
P0 = D1/(rs g) \$21.57

13.Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for \$25.00 per
share. Goode's dividend is expected to grow at a constant rate of 7.00% per year. What
was Goode's last dividend, D0?

A. \$0.95
B. \$1.05
C. \$1.16
D. \$1.27
E. \$1.40