Stocks and Their Valuation Exercise

(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACS letter
indicators !F, M, etc." on the sub#ect lines.
Multiple Choice: True/alse
(10-1) Proxy F G Answer: a EASY
1
. A proxy is a document giving one party the authority to act for another
party, including the power to vote shares of common stock. Proxies can
be important tools relating to control of firms.
a. True
b. False
(10-1) Preemptive right F G Answer: a EASY
. The preemptive right gives current stockholders the right to purchase,

on a pro rata basis, any new shares issued by the firm. This right
helps protect current stockholders against both dilution of control and
dilution of value.
a. True
b. False
(10-1) Preemptive right F G Answer: b EASY
!
. "f a firm#s stockholders are given the preemptive right, this means that
stockholders have the right to call for a meeting to vote to replace the
management. $ithout the preemptive right, dissident stockholders would
have to seek a change in management through a proxy fight.
a. True
b. False
(10-) !"assi#ie$ sto%& F G Answer: a EASY
%
. &lassified stock differentiates various classes of common stock, and
using it is one way companies can meet special needs such as when owners
of a start'up firm need additional e(uity capital but don#t want to
relin(uish voting control.
a. True
b. False
(10-) Fo'n$ers( shares F G Answer: a EASY
)
. Founders# shares are a type of classified stock where the shares are
owned by the firm#s founders, and they generally have more votes per
share than the other classes of common stock.
Chapter 10: Stocks True/False Page 57
2013 Cengage Learning !ll "ights "eser#e$ %a& not 'e copie$( scanne$( or $uplicate$( in )hole or in part( e*cept +or use as per,itte$ in
a license $istri'ute$ )ith a certain pro$uct or ser#ice or other)ise on a pass)or$-protecte$ )e'site +or classroo, use
CH!"TE# $%
&T'C(& !)D THE*# +!L,!T*')
a. True
b. False
(10-)) *ota" sto%& ret'rns F G Answer: b EASY
*
. The total return on a share of stock refers to the dividend yield less
any commissions paid when the stock is purchased and sold.
a. True
b. False
(10-)) !ommon sto%& %ash #"ows F G Answer: a EASY
+
. The cash flows associated with common stock are more difficult to
estimate than those related to bonds because stock has a residual claim
against the company versus a contractual obligation for a bond.
a. True
b. False
(10-)) Sto%& va"'ation F G Answer: b EASY
,
. According to the basic -&F stock valuation model, the value an investor
should assign to a share of stock is dependent on the length of time he
or she plans to hold the stock.
a. True
b. False
(10-)) +argina" investor an$ pri%e F G Answer: a EASY
.
. $hen a new issue of stock is brought to market, it is the marginal
investor who determines the price at which the stock will trade.
a. True
b. False
(10-,) !onstant growth mo$e" F G Answer: a EASY
1/
. The constant growth -&F model used to evaluate the prices of common
stocks is conceptually similar to the model used to find the price of
perpetual preferred stock or other perpetuities.
a. True
b. False
(10--) .on%onstant growth mo$e" F G Answer: a EASY
11
. According to the nonconstant growth model discussed in the textbook, the
discount rate used to find the present value of the expected cash flows
during the initial growth period is the same as the discount rate used
to find the P0s of cash flows during the subse(uent constant growth
period.
a. True
b. False
(10-/) !orporate va"'ation mo$e" F G Answer: b EASY
Page 5. True/False Chapter 10: Stocks
1
. The corporate valuation model can be used only when a company doesn#t
pay dividends.
a. True
b. False
Chapter 10: Stocks True/False Page 5/
(10-/) !orporate va"'ation mo$e" F G Answer: b EASY
1!
. The corporate valuation model cannot be used unless a company pays
dividends.
a. True
b. False
(10-/) Free %ash #"ows an$ va"'ation F G Answer: a EASY
1%
. Pro1ected free cash flows should be discounted at the firm#s weighted
average cost of capital to find the firm2s total corporate value.
a. True
b. False
(10-0) Pre#erre$ sto%& F G Answer: b EASY
1)
. Preferred stock is a hybrid''a sort of cross between a common stock and
a bond''in the sense that it pays dividends that normally increase
annually like a stock but its payments are contractually guaranteed like
interest on a bond.
a. True
b. False
(10-0) Pre#erre$ sto%& F G Answer: a EASY
1*
. From an investor#s perspective, a firm#s preferred stock is generally
considered to be less risky than its common stock but more risky than
its bonds. 3owever, from a corporate issuer#s standpoint, these risk
relationships are reversed4 bonds are the most risky for the firm,
preferred is next, and common is least risky.
a. True
b. False
Multiple Choice: Conceptual
Some of the questions require calculations.
(10-,) !onstant growth mo$e" ! G Answer: % EASY
1+
. $hich of the following statements is &5667&T8
a. The constant growth model is often appropriate for evaluating start'
up companies that do not have a stable history of growth but are
expected to reach stable growth within the next few years.
b. "f a stock has a re(uired rate of return r
s
9 1: and its dividend is
expected to grow at a constant rate of ):, this implies that the
stock2s dividend yield is also ):.
c. The stock valuation model, P
/
9 -
1
;<r
s
' g=, can be used to value
firms whose dividends are expected to decline at a constant rate,
i.e., to grow at a negative rate.
d. The price of a stock is the present value of all expected future
dividends, discounted at the dividend growth rate.
Page 00 Conceptual %/C Chapter 10: Stocks
e. The constant growth model cannot be used for a >ero growth stock,
where the dividend is expected to remain constant over time.
Chapter 10: Stocks Conceptual %/C Page 01
(10-,) 1e2'ire$ ret'rn ! G Answer: e EASY
1,
. An increase in a firm2s expected growth rate would cause its re(uired
rate of return to
a. increase.
b. decrease.
c. fluctuate less than before.
d. fluctuate more than before.
e. possibly increase, possibly decrease, or possibly remain constant.
(10-,) 1e2'ire$ ret'rn ! G Answer: % EASY
1.
. "f in the opinion of a given investor a stock2s expected return exceeds
its re(uired return, this suggests that the investor thinks
a. the stock is experiencing supernormal growth.
b. the stock should be sold.
c. the stock is a good buy.
d. management is probably not trying to maximi>e the price per share.
e. dividends are not likely to be declared.
(10-1) Preemptive right ! G Answer: $ +E345+
/
. The preemptive right is important to shareholders because it
a. allows managers to buy additional shares below the current market
price.
b. will result in higher dividends per share.
c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their
ownership interests.
e. protects bondholders, and thus enables the firm to issue debt with a
relatively low interest rate.
(10-) !"assi#ie$ sto%& ! G Answer: e +E345+
1
. &ompanies can issue different classes of common stock. $hich of the
following statements concerning stock classes is &5667&T8
a. All common stocks fall into one of three classes4 A, ?, and &.
b. All common stocks, regardless of class, must have the same voting
rights.
c. All firms have several classes of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. @ome class or classes of common stock are entitled to more votes per
share than other classes.
(10-,) 1e2'ire$ ret'rn ! G Answer: b +E345+
. @tocks A and ? have the following data. Assuming the stock market is
efficient and the stocks are in e(uilibrium, which of the following
statements is &5667&T8
A ?
6e(uired return 1/: 1:
Aarket price B) B%/
7xpected growth +: .:
a. These two stocks should have the same price.
b. These two stocks must have the same dividend yield.
c. These two stocks should have the same expected return.
d. These two stocks must have the same expected capital gains yield.
e. These two stocks must have the same expected year'end dividend.
(10-,) 1e2'ire$ ret'rn ! G Answer: e +E345+
!
A ?
Price B) B%/
7xpected growth +: .:
7xpected return 1/: 1:
a. The two stocks should have the same expected dividend.
b. The two stocks could not be in e(uilibrium with the numbers given in
the (uestion.
c. A#s expected dividend is B/.)/.
d. ?#s expected dividend is B/.+).
e. A#s expected dividend is B/.+) and ?#s expected dividend is B1./.
(10-,) 3ivi$en$ yie"$ an$ g ! G Answer: a +E345+
%
. @tocks A and ? have the same price and are in e(uilibrium, but @tock A
has the higher re(uired rate of return. $hich of the following
a. "f @tock A has a lower dividend yield than @tock ?, its expected
capital gains yield must be higher than @tock ?2s.
b. @tock ? must have a higher dividend yield than @tock A.
c. @tock A must have a higher dividend yield than @tock ?.
d. "f @tock A has a higher dividend yield than @tock ?, its expected
capital gains yield must be lower than @tock ?2s.
e. @tock A must have both a higher dividend yield and a higher capital
gains yield than @tock ?.
(10-,) 3ivi$en$ yie"$ an$ g ! G Answer: b +E345+
)
. Two constant growth stocks are in e(uilibrium, have the same price, and
have the same re(uired rate of return. $hich of the following
a. The two stocks must have the same dividend per share.
b. "f one stock has a higher dividend yield, it must also have a lower
dividend growth rate.
c. "f one stock has a higher dividend yield, it must also have a higher
dividend growth rate.
d. The two stocks must have the same dividend growth rate.
e. The two stocks must have the same dividend yield.
(10-,) 3ivi$en$ yie"$ an$ g ! G Answer: a +E345+
*
. $hich of the following statements is &5667&T, assuming stocks are in
e(uilibrium8
a. The dividend yield on a constant growth stock must e(ual its expected
total return minus its expected capital gains yield.
b. Assume that the re(uired return on a given stock is 1!:. "f the
stock2s dividend is growing at a constant rate of ):, its expected
dividend yield is ): as well.
c. A stock2s dividend yield can never exceed its expected growth rate.
d. A re(uired condition for one to use the constant growth model is that
the stock2s expected growth rate exceeds its re(uired rate of return.
e. 5ther things held constant, the higher a company2s beta coefficient,
the lower its re(uired rate of return.
(10-,) 3e%"ining %onstant growth ! G Answer: e +E345+
+
. A stock is expected to pay a year'end dividend of B.//, i.e., -
1
9
B.//. The dividend is expected to decline at a rate of ): a year
forever <g 9 '):=. "f the company is in e(uilibrium and its expected
and re(uired rate of return is 1):, which of the following statements is
&5667&T8
a. The company2s current stock price is B/.
b. The company2s dividend yield ) years from now is expected to be 1/:.
c. The constant growth model cannot be used because the growth rate is
negative.
d. The company2s expected capital gains yield is ):.
e. The company2s expected stock price at the beginning of next year is
B..)/.
(10-,) !onstant growth mo$e" ! G Answer: a +E345+
,
a. The constant growth model takes into consideration the capital gains
investors expect to earn on a stock.
b. Two firms with the same expected dividend and growth rate must also
have the same stock price.
c. "t is appropriate to use the constant growth model to estimate a
stock#s value even if its growth rate is never expected to become
constant.
d. "f a stock has a re(uired rate of return r
s
9 1:, and if its
dividend is expected to grow at a constant rate of ):, this implies
that the stock2s dividend yield is also ):.
e. The price of a stock is the present value of all expected future
dividends, discounted at the dividend growth rate.
(10-,) !onstant growth mo$e" ! G Answer: e +E345+
.
. "f a stock2s dividend is expected to grow at a constant rate of ): a
year, which of the following statements is &5667&T8 The stock is in
e(uilibrium.
a. The expected return on the stock is ): a year.
b. The stock2s dividend yield is ):.
c. The price of the stock is expected to decline in the future.
d. The stock2s re(uired return must be e(ual to or less than ):.
e. The stock2s price one year from now is expected to be ): above the
current price.
(10-,) !onstant growth mo$e" ! G Answer: a +E345+
!/
A ?
Price B) B)
7xpected growth <constant= 1/: ):
6e(uired return 1): 1):
a. @tock A#s expected dividend at t 9 1 is only half that of @tock ?.
b. @tock A has a higher dividend yield than @tock ?.
c. &urrently the two stocks have the same price, but over time @tock ?#s
price will pass that of A.
d. @ince @tock A2s growth rate is twice that of @tock ?, @tock A2s
future dividends will always be twice as high as @tock ?2s.
e. The two stocks should not sell at the same price. "f their prices
are e(ual, then a dise(uilibrium must exist.
(10-,) !onstant growth mo$e" ! G Answer: % +E345+
!1
. @tocks C and D have the following data. Assuming the stock market is
C D
Price B!/ B!/
7xpected growth <constant= *: %:
6e(uired return 1: 1/:
a. @tock C has a higher dividend yield than @tock D.
b. @tock D has a higher dividend yield than @tock C.
c. 5ne year from now, @tock C2s price is expected to be higher than
@tock D2s price.
d. @tock C has the higher expected year'end dividend.
e. @tock D has a higher capital gains yield.
(10-,) !onstant growth mo$e" ! G Answer: b +E345+
!
. @tock C has the following data. Assuming the stock market is efficient
and the stock is in e(uilibrium, which of the following statements is
&5667&T8
7xpected dividend, -
1
B!.//
&urrent Price, P
/
B)/
7xpected constant growth rate *./:
a. The stock2s re(uired return is 1/:.
b. The stock2s expected dividend yield and growth rate are e(ual.
c. The stock2s expected dividend yield is ):.
d. The stock2s expected capital gains yield is ):.
e. The stock2s expected price 1/ years from now is B1//.//.
(10-,) !onstant growth mo$e" ! G Answer: b +E345+
!!
. @tocks C and D have the following data. Assuming the stock market is
C D
Price B) B)
7xpected dividend yield ): !:
6e(uired return 1: 1/:
a. @tock D pays a higher dividend per share than @tock C.
b. @tock C pays a higher dividend per share than @tock D.
c. 5ne year from now, @tock C should have the higher price.
d. @tock D has a lower expected growth rate than @tock C.
e. @tock D has the higher expected capital gains yield.
(10-,) !onstant growth mo$e" ! G Answer: $ +E345+
!%
. The expected return on Eatter &orporation2s stock is 1%:. The stock2s
dividend is expected to grow at a constant rate of ,:, and it currently
sells for B)/ a share. $hich of the following statements is &5667&T8
a. The stock2s dividend yield is +:.
b. The stock2s dividend yield is ,:.
c. The current dividend per share is B%.//.
d. The stock price is expected to be B)% a share one year from now.
e. The stock price is expected to be B)+ a share one year from now.
(10-,) !onstant growth mo$e" an$ !AP+ ! G Answer: b +E345+
!)
. @tocks A and ? have the following data. The market risk premium is *./:
and the risk'free rate is *.%:. Assuming the stock market is efficient
and the stocks are in e(uilibrium, which of the following statements is
&5667&T8
A ?
?eta 1.1/ /../
&onstant growth rate +.//: +.//:
a. @tock A must have a higher stock price than @tock ?.
b. @tock A must have a higher dividend yield than @tock ?.
c. @tock ?2s dividend yield e(uals its expected dividend growth rate.
d. @tock ? must have the higher re(uired return.
e. @tock ? could have the higher expected return.
(10-/) !orporate va"'ation mo$e" ! G Answer: b +E345+
!*
. $hich of the following statements is E5T &5667&T8
a. The corporate valuation model can be used both for companies that pay
dividends and those that do not pay dividends.
b. The corporate valuation model discounts free cash flows by the
re(uired return on e(uity.
c. The corporate valuation model can be used to find the value of a
division.
d. An important step in applying the corporate valuation model is
forecasting the firm#s pro forma financial statements.
e. Free cash flows are assumed to grow at a constant rate beyond a
specified date in order to find the hori>on, or continuing, value.
(10-/) !orporate va"'ation mo$e" ! G Answer: a +E345+
!+
a. To implement the corporate valuation model, we discount pro1ected
free cash flows at the weighted average cost of capital.
b. To implement the corporate valuation model, we discount net operating
profit after taxes <E5PAT= at the weighted average cost of capital.
c. To implement the corporate valuation model, we discount pro1ected net
income at the weighted average cost of capital.
d. To implement the corporate valuation model, we discount pro1ected
free cash flows at the cost of e(uity capital.
e. The corporate valuation model re(uires the assumption of a constant
growth rate in all years.
Page 0. Conceptual %/C Chapter 10: Stocks
(10-0) Pre#erre$ sto%& %on%epts ! G Answer: b +E345+
!,
a. Preferred stockholders have a priority over bondholders in the event
of bankruptcy to the income, but not to the proceeds in a
li(uidation.
b. The preferred stock of a given firm is generally less risky to
investors than the same firm2s common stock.
c. &orporations cannot buy the preferred stocks of other corporations.
d. Preferred dividends are not generally cumulative.
e. A big advantage of preferred stock is that dividends on preferred
stocks are tax deductible by the issuing corporation.
(10-0) Pre#erre$ sto%& %on%epts ! G Answer: b +E345+
!.
a. A ma1or disadvantage of financing with preferred stock is that
preferred stockholders typically have supernormal voting rights.
b. Preferred stock is normally expected to provide steadier, more
reliable income to investors than the same firm2s common stock, and,
as a result, the expected after'tax yield on the preferred is lower
than the after'tax expected return on the common stock.
c. The preemptive right is a provision in all corporate charters that
gives preferred stockholders the right to purchase <on a pro rata
basis= new issues of preferred stock.
d. 5ne of the disadvantages to a corporation of owning preferred stock
is that +/: of the dividends received represent taxable income to the
corporate recipient, whereas interest income earned on bonds would be
tax free.
e. 5ne of the advantages to financing with preferred stock is that +/:
of the dividends paid out are tax deductible to the issuer.
(!omp6) !ommon sto%& %on%epts ! G Answer: % +E345+
%/
a. "f a company has two classes of common stock, &lass A and &lass ?,
the stocks may pay different dividends, but under all state charters
the two classes must have the same voting rights.
b. The preemptive right gives stockholders the right to approve or
disapprove of a merger between their company and some other company.
c. The preemptive right is a provision in the corporate charter that
gives common stockholders the right to purchase <on a pro rata basis=
new issues of the firm#s common stock.
d. The stock valuation model, P
/
9 -
1
;<r
s
' g=, cannot be used for firms
that have negative growth rates.
e. The stock valuation model, P
/
9 -
1
;<r
s
' g=, can be used only for
firms whose growth rates exceed their re(uired return.
Chapter 10: Stocks Conceptual %/C Page 0/
(!omp6) !ommon sto%& %on%epts ! G Answer: a +E345+
%1
. The re(uired returns of @tocks C and D are r
C
9 1/: and

r
D
9 1:. $hich
of the following statements is &5667&T8
a. "f the market is in e(uilibrium, and if @tock D has the lower
expected dividend yield, then it must have the higher expected growth
rate.
b. "f @tock D and @tock C have the same dividend yield, then @tock D
must have a lower expected capital gains yield than @tock C.
c. "f @tock C and @tock D have the same current dividend and the same
expected dividend growth rate, then @tock D must sell for a higher
price.
d. The stocks must sell for the same price.
e. @tock D must have a higher dividend yield than @tock C.
Multiple Choice: "ro-lems
Most of these problems are strai$htforward and onl% moderatel% difficult. &owever, a few of the
later ones are relativel% difficult and should be used primaril% on ta'e(home e)ams for students
with some e)perience with *)cel. +roblems with , in the topic line are nonal$orithmic.
(10-,) !onstant growth va"'ation ! G Answer: % EASY
%
. A stock is expected to pay a dividend of B/.+) at the end of the year.
The re(uired rate of return is r
s
9 1/.):, and the expected constant
growth rate is g 9 *.%:. $hat is the stock#s current price8
a. B1+.!.
b. B1+.,%
c. B1,..
d. B1,.+)
e. B1..
(10-,) !onstant growth va"'ation ! G Answer: e EASY
%!
. A stock 1ust paid a dividend of -
/
9 B1.)/. The re(uired rate of return
is r
s
9 1/.1:, and the constant growth rate is g 9 %./:. $hat is the
current stock price8
a. B!.11
b. B!.+/
c. B%.!1
d. B%..!
e. B).)+
(10-,) !onstant growth va"'ation ! G Answer: $ EASY
%%
. A share of common stock 1ust paid a dividend of B1.//. "f the expected
long'run growth rate for this stock is ).%:, and if investors# re(uired
rate of return is 11.%:, what is the stock price8
a. B1*.,
b. B1*.+/
c. B1+.1!
d. B1+.)+
Page 70 %/C Pro'le,s Chapter 10: Stocks
e. B1,./1
(10-,) Expe%te$ $ivi$en$ yie"$ ! G Answer: $ EASY
%)
. "f -
1
9 B1.), g <which is constant= 9 %.+:, and P
/
9 B*.//, what is the
stock2s expected dividend yield for the coming year8
a. %.1:
b. %.!%:
c. %.)+:
d. %.,1:
e. )./):
(10-,) Expe%te$ $ivi$en$ yie"$ ! G Answer: b EASY
%*
. "f -
/
9 B.), g <which is constant= 9 !.):, and P
/
9 B)/, what is the
stock2s expected dividend yield for the coming year8
a. %.%:
b. %.**:
c. %.,.:
d. ).1!:
e. ).!.:
(10-,) Expe%te$ %ap6 gains yie"$ ! G Answer: a EASY
%+
. "f -
1
9 B1.)/, g <which is constant= 9 *.):, and P
/
9 B)*, what is the
stock2s expected capital gains yield for the coming year8
a. *.)/:
b. *.,!:
c. +.1+:
d. +.):
e. +../:
(10-,) Expe%te$ tota" ret'rn ! G Answer: e EASY
%,
. "f -
1
9 B1.), g <which is constant= 9 ).):, and P
/
9 B%%, what is the
stock2s expected total return for the coming year8
a. +.)%:
b. +.+!:
c. +..!:
d. ,.1!:
e. ,.!%:
(10-,) Expe%te$ tota" ret'rn ! G Answer: e EASY
%.
. "f -
/
9 B1.+), g <which is constant= 9 !.*:, and P
/
9 B!.//, what is
the stock2s expected total return for the coming year8
a. ,.!+:
b. ,.).:
c. ,.,1:
d. ../!:
e. ..+:
Chapter 10: Stocks %/C Pro'le,s Page 71
(10-,) !onstant growth rate ! G Answer: e EASY
)/
. Fay Aanufacturing is expected to pay a dividend of B1.) per share at
the end of the year <-
1
9 B1.)=. The stock sells for B!.)/ per share,
and its re(uired rate of return is 1/.):. The dividend is expected to
grow at some constant rate, g, forever. $hat is the e(uilibrium
expected growth rate8
a. *./1:
b. *.1+:
c. *.!!:
d. *.%.:
e. *.*):
(10-,) !onstant growth: #'t're pri%e ! G Answer: e EASY
)1
. 6eddick 7nterprises# stock currently sells for B!).)/ per share. The
dividend is pro1ected to increase at a constant rate of ).)/: per year.
The re(uired rate of return on the stock, r
s
, is ..//:. $hat is the
stock#s expected price ! years from today8
a. B!+.,*
b. B!,.,!
c. B!..,!
d. B%/.,)
e. B%1.*.
(10-,) !onstant growth: #'t're pri%e ! G Answer: e EASY
)
. $hited "nc.#s stock currently sells for B!).) per share. The dividend
is pro1ected to increase at a constant rate of %.+): per year. The
re(uired rate of return on the stock, r
s
, is 11.)/:. $hat is the
stock#s expected price ) years from now8
a. B%/.1+
b. B%1./
c. B%.*
d. B%!.!%
e. B%%.%*
(10-/) !orporate va"'ation mo$e" ! G Answer: % EASY
)!
. Aooradian &orporation2s free cash flow during the 1ust'ended year <t 9
/= was B1)/ million, and its F&F is expected to grow at a constant rate
of )./: in the future. "f the weighted average cost of capital is
1.):, what is the firm2s total corporate value, in millions8
a. B1,,.)
b. B1,..)
c. B,1//
d. B,/)
e. B,!1)
(10-/) !orporate va"'ation mo$e" ! G Answer: $ EASY
)%
. @uppose ?oyson &orporation2s pro1ected free cash flow for next year is
F&F
1
9 B1)/,///, and F&F is expected to grow at a constant rate of *.):.
"f the company2s weighted average cost of capital is 11.):, what is the
firm2s total corporate value8
a. B,)+,1)
b. B,+/+,)//
c. B,,)/,///
d. B!,///,///
e. B!,1)/,///
(10-0) Pre#erre$ sto%& va"'ation ! G Answer: e EASY
))
. Aolen "nc. has an outstanding issue of perpetual preferred stock with an
annual dividend of B+.)/ per share. "f the re(uired return on this
preferred stock is *.):, at what price should the stock sell8
a. B1/%.+
b. B1/*..)
c. B1/..*.
d. B11.)/
e. B11).!,
(10-,) !onstant growth va"'ation: !AP+ ! G Answer: a +E345+
)*
. The Francis &ompany is expected to pay a dividend of -
1
9 B1.) per
share at the end of the year, and that dividend is expected to grow at a
constant rate of *.//: per year in the future. The company#s beta is
1.1), the market risk premium is ).)/:, and the risk'free rate is %.//:.
$hat is the company#s current stock price8
a. B,../
b. B..*
c. B!/.!*
d. B!1.1
e. B!1../
)+
. The "sberg &ompany 1ust paid a dividend of B/.+) per share, and that
dividend is expected to grow at a constant rate of ).)/: per year in the
future. The company#s beta is 1.1), the market risk premium is ).//:,
and the risk'free rate is %.//:. $hat is the company#s current stock
price, P
/
8
a. B1,.*
b. B1../,
c. B1..)*
d. B/./)
e. B/.))
),
. @chnusenberg &orporation 1ust paid a dividend of -
/
9 B/.+) per share,
and that dividend is expected to grow at a constant rate of *.)/: per
year in the future. The company#s beta is 1.), the re(uired return on
the market is 1/.)/:, and the risk'free rate is %.)/:. $hat is the
company#s current stock price8
a. B1%.)
b. B1%.,.
c. B1).*
d. B1).*%
e. B1*./!
(10-,) !onstant growth $ivi$en$ ! G Answer: b +E345+
).
. Foode "nc.#s stock has a re(uired rate of return of 11.)/:, and it sells
for B).// per share. Foode#s dividend is expected to grow at a
constant rate of +.//:. $hat was the last dividend, -
/
8
a. B/..)
b. B1./)
c. B1.1*
d. B1.+
e. B1.%/
(10-,) !onstant growth $ivi$en$ ! G Answer: b +E345+
*/
. Francis "nc.#s stock has a re(uired rate of return of 1/.):, and it
sells for B)+.)/ per share. The dividend is expected to grow at a
constant rate of *.//: per year. $hat is the expected year'end
dividend, -
1
8
a. B./
b. B.%%
c. B.*.
d. B..*
e. B!.)
(10-,) !onstant growth: #'t're pri%e ! G Answer: a +E345+
*1
. @orenson &orp.2s expected year'end dividend is -
1
9 B1.*/, its re(uired
return is r
s
9 11.//:, its dividend yield is *.//:, and its growth rate
is expected to be constant in the future. $hat is @orenson#s expected
stock price in + years, i.e., what is
+
P
7
8
a. B!+.)
b. B!..%/
c. B%1.!+
d. B%!.%%
e. B%).*1
(10-/) !orporate va"'ation mo$e" ! G Answer: e +E345+
*
. Fupta &orporation is undergoing a restructuring, and its free cash flows
are expected to vary considerably during the next few years. 3owever,
the F&F is expected to be B*).// million in Dear ), and the F&F growth
rate is expected to be a constant *.): beyond that point. The weighted
average cost of capital is 1./:. $hat is the hori>on <or continuing=
value <in millions= at t 9 )8
a. B1,/)
b. B1,/+.
c. B1,1!*
d. B1,1.*
e. B1,).
*!
. Aisra "nc. forecasts a free cash flow of B!) million in Dear !, i.e., at
t 9 !, and it expects F&F to grow at a constant rate of ).): thereafter.
"f the weighted average cost of capital <$A&&= is 1/./: and the cost of
e(uity is 1)./:, what is the hori>on, or continuing, value in millions
at t 9 !8
a. B,1
b. B,*
c. B./)
d. B.)/
e. B..+
(10-/) !orporate va"'ation mo$e" ! G Answer: % +E345+
*%
. Dou must estimate the intrinsic value of Eoe Technologies2 stock. The
end'of'year free cash flow <F&F
1
= is expected to be B+.)/ million, and
it is expected to grow at a constant rate of +./: a year thereafter.
The company2s $A&& is 1/./:, it has B1)./ million of long'term debt
plus preferred stock outstanding, and there are 1)./ million shares of
common stock outstanding. $hat is the firm#s estimated intrinsic value
per share of common stock8
a. B%,.*%
b. B)/.*+
c. B).+,
d. B)%.,.
e. B)+./,
*)
. Dou have been assigned the task of using the corporate, or free cash
flow, model to estimate Petry &orporation#s intrinsic value. The firm#s
$A&& is 1/.//:, its end'of'year free cash flow <F&F
1
= is expected to be
B+)./ million, the F&Fs are expected to grow at a constant rate of ).//:
a year in the future, the company has B// million of long'term debt and
preferred stock, and it has !/ million shares of common stock
outstanding. $hat is the firm#s estimated intrinsic value per share of
common stock8
a. B%/.!)
b. B%1.,
c. B%!.!!
d. B%%.,)
e. B%*.%
**
. Gedia "nc. forecasts a negative free cash flow for the coming year, F&F
1
9 'B1/ million, but it expects positive numbers thereafter, with F&F
9
B) million. After Dear , F&F is expected to grow at a constant rate
of %: forever. "f the weighted average cost of capital is 1%./:, what
is the firm2s total corporate value, in millions8
a. B//.//
b. B1/.)!
c. B1./)
d. B!.11
e. B%!.+1
*+
. Gale "nc. forecasts the free cash flows <in millions= shown below. "f
the weighted average cost of capital is 11./: and F&F is expected to
grow at a rate of )./: after Dear , what is the firm2s total corporate
value, in millions8
Dear 1
Free cash flow 'B)/ B1//
a. B1,%)*
b. B1,).
c. B1,*/*
d. B1,*,*
e. B1,++/
(10-/) !orporate va"'ation mo$e" ! G Answer: e +E345+
*,
. 6yan 7nterprises forecasts the free cash flows <in millions= shown
below. The weighted average cost of capital is 1!./:, and the F&Fs are
expected to continue growing at a )./: rate after Dear !. $hat is the
firm2s total corporate value, in millions8
Dear 1 !
F&F 'B1)./ B1/./ B%/./
a. B!1%.)1
b. B!!1./*
c. B!%,.%,
d. B!**.,
e. B!,*.1!
(10-/) !orporate va"'ation mo$e" ! G Answer: $ +E345+
*.
. ?ased on the corporate valuation model, $ang "nc.2s total corporate
value is B+)/ million. "ts balance sheet shows B1// million notes
payable, B// million of long'term debt, B%/ million of common stock
<par plus paid'in'capital=, and B1*/ million of retained earnings. $hat
is the best estimate for the firm2s value of e(uity, in millions8
a. B!,*
b. B%/*
c. B%,
d. B%)/
e. B%+!
+/
. ?ased on the corporate valuation model, Fay 7ntertainment#s total
corporate value is B1,// million. The company2s balance sheet shows
B1/ million of notes payable, B!// million of long'term debt, B)/
million of preferred stock, B1,/ million of retained earnings, and B,//
million of total common e(uity. "f the company has !/ million shares of
stock outstanding, what is the best estimate of its price per share8
a. B1../
b. B%.!!
c. B*.++
d. B..%%
e. B!.!.
+1
. ?ased on the corporate valuation model, the total corporate value of
&hen Hin "nc. is B.// million. "ts balance sheet shows B11/ million in
notes payable, B./ million in long'term debt, B/ million in preferred
stock, B1%/ million in retained earnings, and B,/ million in total
common e(uity. "f the company has ) million shares of stock
outstanding, what is the best estimate of its stock price per share8
a. B./!
b. B%.%,
c. B+./
d. B...
e. B!..1
(10-/) !orporate va"'ation mo$e" ! G Answer: $ +E345+
+
. ?ased on the corporate valuation model, Aorgan "nc.2s total corporate
value is B!// million. The balance sheet shows B./ million of notes
payable, B!/ million of long'term debt, B%/ million of preferred stock,
and B1// million of common e(uity. The company has 1/ million shares of
stock outstanding. $hat is the best estimate of the stock2s price per
share8
a. B1.//
b. B1.*%
c. B1!.!/
d. B1%.//
e. B1%.+/
(10-0) Pre#erre$ re2'ire$ ret'rn ! G Answer: e +E345+
+!
. &arter#s preferred stock pays a dividend of B1.// per (uarter. "f the
price of the stock is B%).//, what is its nominal <not effective= annual
rate of return8
a. ,./!:
b. ,.%:
c. ,.%):
d. ,.*+:
e. ,.,.:
Page 7. %/C Pro'le,s Chapter 10: Stocks
(10-0) Pre#erre$ re2'ire$ ret'rn ! G Answer: e +E345+
+%
. 6ebello#s preferred stock pays a dividend of B1.// per (uarter, and it
sells for B)).// per share. $hat is its effective annual <not nominal=
rate of return8
a. *.*:
b. *.,:
c. +./!:
d. +.):
e. +.%+:
(10--) .on%onstant growth va"'ation ! G Answer: $ +E345+89A13
+)
. Eachman "ndustries 1ust paid a dividend of -
/
9 B1.!. Analysts expect
the company#s dividend to grow by !/: this year, by 1/: in Dear , and
at a constant rate of ): in Dear ! and thereafter. The re(uired return
on this low'risk stock is ..//:. $hat is the best estimate of the
stock2s current market value8
a. B%1.).
b. B%.*)
c. B%!.+)
d. B%%.,+
e. B%)...
(10--) .on%onstant growth va"'ation ! G Answer: % 9A13
+*
. &hurch "nc. is presently en1oying relatively high growth because of a
surge in the demand for its new product. Aanagement expects earnings
and dividends to grow at a rate of ): for the next % years, after which
competition will probably reduce the growth rate in earnings and
dividends to >ero, i.e., g 9 /. The company2s last dividend, -
/
, was
B1.), its beta is 1./, the market risk premium is ).)/:, and the risk'
free rate is !.//:. $hat is the current price of the common stock8
a. B*.++
b. B+.,.
c. B../)
d. B!/.1
e. B!1.%
(10--) .on%onstant growth va"'ation ! G Answer: b 9A13
++
. The 6amire> &ompany#s last dividend was B1.+). "ts dividend growth rate
is expected to be constant at ): for years, after which dividends are
expected to grow at a rate of *: forever. "ts re(uired return <r
s
= is
1:. $hat is the best estimate of the current stock price8
a. B%1.),
b. B%.*%
c. B%!.+1
d. B%%.,/
e. B%)..
Chapter 10: Stocks %/C Pro'le,s Page 7/
(10--) .on%onstant growth va"'ation ! G Answer: a 9A13
+,
. Ackert &ompany#s last dividend was B1.)). The dividend growth rate is
expected to be constant at 1.): for years, after which dividends are
expected to grow at a rate of ,./: forever. The firm#s re(uired return
<r
s
= is 1./:. $hat is the best estimate of the current stock price8
a. B!+./)
b. B!,.1*
c. B!..!/
d. B%/.%,
e. B%1.+/
(10--) .on%onstant growth va"'ation ! G Answer: $ 9A13
+.
. 3uang &ompany#s last dividend was B1.). The dividend growth rate is
expected to be constant at 1): for ! years, after which dividends are
expected to grow at a rate of *: forever. "f the firm#s re(uired return
<r
s
= is 11:, what is its current stock price8
a. B!/.)+
b. B!1.)
c. B!.%.
d. B!!.)/
e. B!%.)/
(10--) .on%onstant growth va"'ation ! G Answer: $ 9A13
,/
. Agarwal Technologies was founded 1/ years ago. "t has been profitable
for the last ) years, but it has needed all of its earnings to support
growth and thus has never paid a dividend. Aanagement has indicated
that it plans to pay a B/.) dividend ! years from today, then to
increase it at a relatively rapid rate for years, and then to increase
it at a constant rate of ,.//: thereafter. Aanagement#s forecast of the
future dividend stream, along with the forecasted growth rates, is shown
below. Assuming a re(uired return of 11.//:, what is your estimate of
the stock#s current value8
Dear / 1 ! % ) *
Frowth rate EA EA EA EA )/.//: ).//: ,.//:
-ividends B/./// B/./// B/./// B/.)/ B/.!+) B/.%*. B/.)/*
a. B ...%
b. B1/.1.
c. B1/.%)
d. B1/.+
e. B1/...
Page .0 %/C Pro'le,s Chapter 10: Stocks
(10-/) !orporate va"'ation mo$e" ! G Answer: b 9A13
,1
. $all "nc. forecasts that it will have the free cash flows <in millions=
shown below. "f the weighted average cost of capital is 1%: and the
free cash flows are expected to continue growing at the same rate after
Dear ! as from Dear to Dear !, what is the firm2s total corporate
value, in millions8
Dear 1 !
Free cash flow 'B/.// B%,.// B)%.//
a. B,*)/.//
b. B,+,..%+
c. B,.,..)
d. B!,/+).!.
e. B!,..1*
(10--) .on%onstant growth rate: ! G Answer: e ;E1Y 9A13
,
. @avickas Petroleum2s stock has a re(uired return of 1:, and the stock
sells for B%/ per share. The firm 1ust paid a dividend of B1.//, and
the dividend is expected to grow by !/: per year for the next % years,
so -
%
9 B1.//<1.!/=
%
9 B.,)*1. After t 9 %, the dividend is expected
to grow at a constant rate of C: per year forever. $hat is the stock2s
expected constant growth rate after t 9 %, i.e., what is C8
a. ).1+:
b. ).%%:
c. ).+:
d. *./:
e. *.!%:
Chapter 10: Stocks %/C Pro'le,s Page .1
(10--) .on%onstant va"'ation--'se Ex%e": ! G < Answer: $ ;E1Y 9A13
,!
. Dour boss, @ally Aaloney, treasurer of Fred &lark 7nterprises <F&7=,
asked you to help her estimate the intrinsic value of the company#s
stock. F&7 1ust paid a dividend of B1.//, and the stock now sells for
B1).// per share. @ally asked a number of security analysts what they
believe F&7#s future dividends will be, based on their analysis of the
company. The consensus is that the dividend will be increased by 1/:
during Dears 1 to !, and it will be increased at a rate of ): per year
in Dear % and thereafter. @ally asked you to use that information to
estimate the re(uired rate of return on the stock, r
s
, and she provided
you with the following template for use in the analysis.
@ally told you that the growth rates in the template were 1ust put in as
a trial, and that you must replace them with the analysts# forecasted
rates to get the correct forecasted dividends and then the estimated 30.
@he also notes that the estimated value for r
s,
at the top of the
template, is also 1ust a guess, and you must replace it with a value
that will cause the &alculated Price shown at the bottom to e(ual the
Actual Aarket Price. @he suggests that, after you have put in the
correct dividends, you can manually calculate the price, using a series
of guesses as to the 7stimated r
s
. The value of r
s
that causes the
calculated price to e(ual the actual price is the correct one. @he
notes, though, that this trial'and'error process would be (uite tedious,
and that the correct r
s
could be found much faster with a simple 7xcel
model, especially if you use Foal @eek. $hat is the value of r
s
8
a. 11.,%:
b. 1.1:
c. 1.),:
d. 1..+:
e. 1!.!*:
Page .2 %/C Pro'le,s Chapter 10: Stocks
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACS letter
indicators !F, M, etc." on the sub#ect lines.
Multiple Choice: True/alse
(10A) Sto%& mar&et e2'i"ibri'm F G Answer: a EASY
,%
. "f a stock#s expected return as seen by the marginal investor exceeds
this investor#s re(uired return, then the investor will buy the stock
until its price has risen enough to bring the expected return down to
e(ual the re(uired return.
a. True
b. False
,)
. "f a stock#s market price exceeds its intrinsic value as seen by the
marginal investor, then the investor will sell the stock until its price
has fallen down to the level of the investor#s estimate of the intrinsic
value.
a. True
b. False
,*
. For a stock to be in e(uilibrium, two conditions are necessary4 <1= The
stock#s market price must e(ual its intrinsic value as seen by the
marginal investor and <= the expected return as seen by the marginal
investor must e(ual this investor#s re(uired return.
a. True
b. False
(10A) Sto%& mar&et e2'i"ibri'm F G Answer: b EASY
,+
. Two conditions are used to determine whether or not a stock is in
e(uilibrium4 <1= -oes the stock#s market price e(ual its intrinsic value
as seen by the marginal investor, and <= does the expected return on
the stock as seen by the marginal investor e(ual this investor#s
re(uired return8 "f either of these conditions, but not necessarily
both, holds, then the stock is said to be in e(uilibrium.
a. True
b. False
!ppen$i* 10!: Stock %arket 23uili'riu, True/False Page .3
!""E)D*. $%!
&T'C( M!#(ET E/,*L*0#*,M
Multiple Choice: Conceptual
(10A) +ar&et e2'i"ibri'm ! G Answer: b EASY
,,
. "f markets are in e(uilibrium, which of the following conditions will
exist8
a. 7ach stock2s expected return should e(ual its reali>ed return as seen
by the marginal investor.
b. 7ach stock2s expected return should e(ual its re(uired return as seen
by the marginal investor.
c. All stocks should have the same expected return as seen by the
marginal investor.
d. The expected and re(uired returns on stocks and bonds should be
e(ual.
e. All stocks should have the same reali>ed return during the coming
year.
(10A) +ar&et e2'i"ibri'm ! G Answer: e +E345+
,.
. For a stock to be in e(uilibrium, that is, for there to be no long'term
pressure for its price to depart from its current level, then
a. the expected future return must be less than the most recent past
reali>ed return.
b. the past reali>ed return must be e(ual to the expected return during
the same period.
c. the re(uired return must e(ual the reali>ed return in all periods.
d. the expected return must be e(ual to both the re(uired future return
and the past reali>ed return.
e. the expected future return must be e(ual to the re(uired return.
Page .1 Conceptual %/C !ppen$i* 10!: Stock %arket 23uili'riu,
Chapter 10: Stocks !ns)ers Page .5
CH!"TE# $%
!)&1E#& !)D &'L,T*')&
16 (10-1) Proxy F G Answer: a EASY
6 (10-1) Preemptive right F G Answer: a EASY
!6 (10-1) Preemptive right F G Answer: b EASY
%6 (10-) !"assi#ie$ sto%& F G Answer: a EASY
)6 (10-) Fo'n$ers( shares F G Answer: a EASY
*6 (10-)) *ota" sto%& ret'rns F G Answer: b EASY
+6 (10-)) !ommon sto%& %ash #"ows F G Answer: a EASY
,6 (10-)) Sto%& va"'ation F G Answer: b EASY
.6 (10-)) +argina" investor an$ pri%e F G Answer: a EASY
1/6 (10-,) !onstant growth mo$e" F G Answer: a EASY
116 (10--) .on%onstant growth mo$e" F G Answer: a EASY
16 (10-/) !orporate va"'ation mo$e" F G Answer: b EASY
1!6 (10-/) !orporate va"'ation mo$e" F G Answer: b EASY
1%6 (10-/) Free %ash #"ows an$ va"'ation F G Answer: a EASY
1)6 (10-0) Pre#erre$ sto%& F G Answer: b EASY
Preferred dividends don't normally grow, and they are not guaranteed.
1*6 (10-0) Pre#erre$ sto%& F G Answer: a EASY
1+6 (10-,) !onstant growth mo$e" ! G Answer: % EASY
1,6 (10-,) 1e2'ire$ ret'rn ! G Answer: e EASY
1.6 (10-,) 1e2'ire$ ret'rn ! G Answer: % EASY
/6 (10-1) Preemptive right ! G Answer: $ +E345+
16 (10-) !"assi#ie$ sto%& ! G Answer: e +E345+
6 (10-,) 1e2'ire$ ret'rn ! G Answer: b +E345+

The following calculations show that answer b is correct. The others are all wrong.
A B
Expected return !" #"
Expected growth $" %"
&ividend yield '" '"
!6 (10-,) 1e2'ire$ ret'rn ! G Answer: e +E345+
The following calculations show that answer e is correct. The others are all wrong.
A B
Price (#) (*!
Expected growth $" %"
Expected return !" #"
A + P! + &,-r g. + &+P!-r. / P!-g. + (!.$)
B + P! + &,-r / g. + &+P!-r. P!-g. + (.#!
%6 (10-,) 3ivi$en$ yie"$ an$ g ! G Answer: a +E345+
0tatement a is true, because if the re1uired return for 0toc2 A is higher than that of 0toc2 B, and if the dividend
yield for 0toc2 A is lower than 0toc2 B3s, the growth rate for 0toc2 A must be higher to offset this.
)6 (10-,) 3ivi$en$ yie"$ an$ g ! G Answer: b +E345+
*6 (10-,) 3ivi$en$ yie"$ an$ g ! G Answer: a +E345+
+6 (10-,) 3e%"ining %onstant growth ! G Answer: e +E345+
4ote that P! + (#,-!.) 5 !.!). + (!. That price is expected to decline by )" each year, so P must be (!-!.%).
+ (%.)!. Therefore, answer e is correct, while the others are all false.
,6 (10-,) !onstant growth mo$e" ! G Answer: a +E345+
0tatement a is true, because the expected growth rate is also the expected capital gains yield. All the other
statements are false.
.6 (10-,) !onstant growth mo$e" ! G Answer: e +E345+
0tatement e is true, because the stoc2 price is expected to grow at the dividend growth rate.
!/6 (10-,) !onstant growth mo$e" ! G Answer: a +E345+
0tatement a is correct, because if both stoc2s have the same price and the same re1uired return, and A3s growth
rate is twice that of B, then A3s dividend and dividend yield must be half that of B. This point is illustrated
with the following example.
A B
Price (#) (#)
g !" )"
r )" )"
&iv. 6ield + r g + )" !"
& + P-&iv 6ield. + (.#) (#.)!
!16 (10-,) !onstant growth mo$e" ! G Answer: % +E345+
The correct answer is statement c. Both prices are currently the same, but 7's price should grow at 8" vs. *" for
6, so 7's price should be higher a year from now.
!6 (10-,) !onstant growth mo$e" ! G Answer: b +E345+
The correct answer choice is b. 9ne could 1uic2ly calculate the dividend yield and see that it e1uals the growth
rate, but here are some numbers that provide more information.
& ('.!! &,P! 8.!"
P! ()!.!! r7 #.!"
g 8.!"
!!6 (10-,) !onstant growth mo$e" ! G Answer: b +E345+
&ividend + 6ield : Price; 7 dividend + (.#) 6 dividend + (!.$)
0toc2 7 has a dividend yield of )" versus a dividend yield of '" for 6. 0ince they both have the same stoc2
price, 7 must pay a higher dividend.
!%6 (10-,) !onstant growth mo$e" ! G Answer: $ +E345+
P + P!- 5 g. + ()*. Therefore, d is correct. All the other answers are false. P + ()*.!!
!)6 (10-,) !onstant growth mo$e" an$ !AP+ ! G Answer: b +E345+
0tatement b is true, because 0toc2 A has a higher re1uired return but the stoc2s have the same growth rate, so
0toc2 A must have the higher dividend yield. <ere are some calculations to demonstrate the point.
r=> beta =P? r0toc2
A 8.*!" 5 .! 8.!!" + '.!!"
B 8.*!" 5 !.%! 8.!!" + .@!"
&iv. 6ld. g r0toc2
A &,P! 5 $.!!" + '.!!" &,P! + r g + 8.!!"
B &,P! 5 $.!!" + .@!" &,P! + r g + *.@!"
!*6 (10-/) !orporate va"'ation mo$e" ! G Answer: b +E345+
!+6 (10-/) !orporate va"'ation mo$e" ! G Answer: a +E345+
!,6 (10-0) Pre#erre$ sto%& %on%epts ! G Answer: b +E345+
!.6 (10-0) Pre#erre$ sto%& %on%epts ! G Answer: b +E345+
%/6 (!omp6) !ommon sto%& %on%epts ! G Answer: % +E345+
0tatement a is falseAa number of companies have different classes of stoc2 with different voting rights.
0tatement b is simply false. 0tatement c is true. 0tatements d and e are false, because the constant growth model
can be used anytime as long as the constant growth rate is less than the re1uired return -even if the growth rate is
negative..
%16 (!omp6) !ommon sto%& %on%epts ! G Answer: a +E345+
0ince 7 has the lower re1uired return, if 6 has a lower dividend yield it must have a higher expected growth rate.
%6 (10-,) !onstant growth va"'ation ! G Answer: % EASY
& (!.$)
rs !.)"
g 8.*"
P! + &,-rs B g. (@.#%
%!6 (10-,) !onstant growth va"'ation ! G Answer: e EASY
&! (.)!
rs !."
g *.!"
& + &!- 5 g. + (.)8
P! + &,-rs B g. (#).)$
%%6 (10-,) !onstant growth va"'ation ! G Answer: $ EASY
Cast dividend -&!. (.!!
CongDrun growth rate ).*"
=e1uired return .*"
& + &!- 5 g. + (.!)*
P! + &,-rs B g. ($.)$
%)6 (10-,) Expe%te$ $ivi$en$ yie"$ ! G Answer: $ EASY
& (.#)
g *.$"
P! (#8.!!
&ividend yield + &,P! + *.@"
%*6 (10-,) Expe%te$ $ivi$en$ yie"$ ! G Answer: b EASY
&! (#.#)
g '.)"
P! ()!.!!
& + &!- 5 g. + (#.'#%
&ividend yield + &,P! + *.88"
%+6 (10-,) Expe%te$ %ap6 gains yie"$ ! G Answer: a EASY
& (.)!
g 8.)"
P! ()8.!!
Eapital gains yield + g + 8.)!"
%,6 (10-,) Expe%te$ tota" ret'rn ! G Answer: e EASY
& (.#)
g ).)"
P! (**.!!
Total return + rs + &,P! 5 g @.'*"
%.6 (10-,) Expe%te$ tota" ret'rn ! G Answer: e EASY
&! (.$)
g '.8"
P! ('#.!!
& + &!- 5 g. + (.@
Total return + rs + &,P! 5 g %.#$"
)/6 (10-,) !onstant growth rate ! G Answer: e EASY
Expected dividend -&. (.#)
0toc2 price ('#.)!
=e1uired return !.)"
&ividend yield '.@)"
Frowth rate + rs &,P! + 8.8)"
)16 (10-,) !onstant growth: #'t're pri%e ! G Answer: e EASY
0toc2 price (').)!
Frowth rate ).)!"
6ears in the future '
P' + P!- 5 g.
'
+ (*.8%
)6 (10-,) !onstant growth: #'t're pri%e ! G Answer: e EASY
Frowth rate *.$)"
6ears in the future )
0toc2 price (').#)
P) + P!- 5 g.
)
+ (**.*8
)!6 (10-/) !orporate va"'ation mo$e" ! G Answer: % EASY
>E>! ()!
g ).!"
GAEE #.)"
>E> + >E>!- 5 g. + ()$.)!
Total corporate value + >E>,-GAEE / g. + (#,!!.!!
)%6 (10-/) !orporate va"'ation mo$e" ! G Answer: $ EASY
>E> ()!,!!!
g 8.)!"
GAEE .)!"
Total corporate value + >E>,-GAEE / g. + (',!!!,!!!
))6 (10-0) Pre#erre$ sto%& va"'ation ! G Answer: e EASY
Preferred dividend ($.)!
=e1uired return 8.)"
Preferred price + &P,rP + ().'@
)*6 (10-,) !onstant growth va"'ation: !AP+! G Answer: a +E345+
& (.#)
b .)
r=> *.!!"
=P? ).)!"
g 8.!!"
rs + r=> 5 b-=P?. + !.''"
P! + &,-rs g. (#@.%!
)+6 (10-,) !onstant growth va"'ation: !AP+! G Answer: a +E345+
&! (!.$)
b .)
r=> *.!"
=P? ).!"
g ).)"
& + &!- 5 g. + (!.$%'
rs + r=> 5 b-=P?. + %.$)"
P! + &,-rs B g. (@.8#
),6 (10-,) !onstant growth va"'ation: !AP+! G Answer: a +E345+
&! (!.$)
b .#)
r=> *.)"
r? !.)"
g 8.)"
& + &!- 5 g. + (!.$%@@
rs + r=> 5 b-r? B ==>. + #.!"
P! + &,-rs B g. (*.)#
).6 (10-,) !onstant growth $ivi$en$ ! G Answer: b +E345+
0toc2 price (#).!!
=e1uired return .)!"
Frowth rate $.!!"
P! + &,-rs B g., so & + P!-rs B g. + (.#)!
Cast dividend + &! + &,- 5 g. (.!)
*/6 (10-,) !onstant growth $ivi$en$ ! G Answer: b +E345+
0toc2 price ()$.)!
=e1uired return !.#)"
Frowth rate 8.!!"
P! + &,-rs B g., so & + P!-rs B g.
Expected dividend + & + P!-rs B g. + (#.**
*16 (10-,) !onstant growth: #'t're pri%e ! G Answer: a +E345+
4ext expected dividend + & + (.8!
=e1uired return .!"
&ividend yield + &,P! + 8.!"
>ind the growth rate; g + rs B yield + ).!"
>ind P! + &,-rs B g. + (#8.8$
6ears in the future $
$
P
7
+ P!- 5 g.
$
('$.)#
*6 (10-/) !orporate va"'ation mo$e" ! G Answer: e +E345+
E>) (8).!!
g 8.)"
GAEE #.!"
>E>8 + >E>)- 5 g. + (8%.##)!
<H) + >E>8,-GAEE / g. + (,#)@.8*
*!6 (10-/) !orporate va"'ation mo$e" ! G Answer: a +E345+
>E>' (').!!
g ).)"
GAEE !.!"
>E>* + >E>'- 5 g. + ('8.%#)!
<H' + >E>*,-GAEE / g. + (@#!.)8
*%6 (10-/) !orporate va"'ation mo$e" ! G Answer: % +E345+
>E> (#$.)!
Eonstant growth rate $.!"
GAEE !.!"
&ebt I preferred stoc2 (#)
0hares outstanding )
Total firm value + >E>,-GAEE B g. + (%8.8$
Cess; Halue of debt I preferred D(#).!!
Halue of e1uity ($%.8$
4umber of shares )
Halue per share + E1uity value,0hares + ()#.$@
*)6 (10-/) !orporate va"'ation mo$e" ! G Answer: % +E345+
>E> ($).!!
Eonstant growth rate ).!"
GAEE !.!"
&ebt I preferred stoc2 (#!!
0hares outstanding '!
Total firm value + >E>,-GAEE B g. + (,)!!.!!
Cess; Halue of debt I preferred D(#!!.!!
Halue of e1uity (,'!!.!!
4umber of shares '!
Halue per share + E1uity value,0hares + (*'.''
**6 (10-/) !orporate va"'ation mo$e" ! G Answer: b +E345+
>E> D(!
>E># (#)
g *"
GAEE *"
>irst, find the horiJon, or continuing, value at t + #;
<H# + >E>#- 5 g.,-GAEE / g. + (#)-.!*.,-!.* / !.!*. + (#8.!,!.! + (#8!.!!
Then find the PH of the free cash flows and the horiJon value;
Total corporate value + D(!,-.*.
5 -(#) 5 (#8!.,-.*.
#
Total corporate value + D(@.$$# 5 (#%.#%@ + (#!.)'
*+6 (10-/) !orporate va"'ation mo$e" ! G Answer: a +E345+
>E> D()!
>E># (!!
g )"
GAEE "
>irst, find the horiJon, or continuing, value;
<H# + >E>#- 5 g.,-GAEE / g. + (!!-.!).,-!. / !.!). + (,$)!.!!
Then find the PH of the free cash flows and the horiJon value;
Total corporate value + D()!,-.. 5 -(!! 5 (,$)!.,-..
#
+(,*)8.*8
*,6 (10-/) !orporate va"'ation mo$e" ! G Answer: e +E345+
g )"
GAEE '"
6ear # ' *
>E> D().!! (!.!! (*!.!! (*#.!!
<oriJon, or continuing, value ()#) .!! + >E>'- 5 g.,-GAEE / g.
Annual >E> D().!! (!.!! ()8).!!
PHs at '" D('.#$ ($.@' ('%.)$
Total corporate value + 0um + ('@8.'
*.6 (10-/) !orporate va"'ation mo$e" ! G Answer: $ +E345+
Assuming that the boo2 value of debt is close to its mar2et value, the total mar2et value of the company is;
Total corporate value ($)!
4otes payable D(!!
CongDterm debt D(#!!
Halue of e1uity + (*)!
The boo2 value of e1uity figures are irrelevant for this problem.
+/6 (10-/) !orporate va"'ation mo$e" ! G Answer: b +E345+
Assuming that the boo2 value of debt is close to its mar2et value, the total mar2et value of the firm3s e1uity is;
Total corporate value (,#!!
4otes payable D(#!
CongDterm debt D('!!
Preferred stoc2 D()!
?H e1uity ($'!
0hares outstanding '!
0toc2 price + Halue of e1uity,0hares outstanding + (#*.''
+16 (10-/) !orporate va"'ation mo$e" ! G Answer: % +E345+
Total corporate value (%!!
4otes payable D(!
CongDterm debt D(%!
Preferred stoc2 D(#!
?H e1uity (8@!
0hares outstanding #)
0toc2 price + Halue of e1uity,0hares outstanding + (#$.#!
+6 (10-/) !orporate va"'ation mo$e" ! G Answer: $ +E345+
Total corporate value ('!!
4otes payable D(%!
CongDterm debt D('!
Preferred stoc2 D(*!
?H e1uity (*!
0hares outstanding !
0toc2 price + Halue of e1uity,0hares outstanding + (*.!!
The boo2 value of e1uity figures are irrelevant for this problem
+!6 (10-0) Pre#erre$ re2'ire$ ret'rn ! G Answer: e +E345+
Pref. 1uarterly dividend (.!!
Annual dividend + Ktrly dividend : * + (*.!!
Preferred stoc2 price (*).!!
4om. re1uired return + Annual dividend,Price + @.@%"
+%6 (10-0) Pre#erre$ re2'ire$ ret'rn ! G Answer: e +E345+
Periods per year + *
Pref. 1uarterly dividend (.!!
Preferred stoc2 price ()).!!
Eff " re1uired return + -5 -Kt &iv,P..
4
B + $.*$"
+)6 (10--) .on%onstant growth va"'ation ! G Answer: $ +E345+89A13
rs + %.!"
6ear ! # '
Frowth rates; '!.!" !.!" ).!"
&ividend (.'# (.$8 (.@@@ (.%@#
<oriJon value + &',-rs B g'. + *% .))!
Total E>s (.$8 ().*'$
PH of E>s (.)$* (*'.#%*
0toc2 price + (**.@$
+*6 (10--) .on%onstant growth va"'ation ! G Answer: % 9A13
Cast dividend -&!. (.#)
0hortDrun growth rate #)"
CongDrun growth rate !"
Beta .#!
?ar2et ris2 premium ).)!"
=is2Dfree rate '.!!"
=e1uired return + rs + r=> 5 b-=P?. + %.8!"
6ear ! # ' * )
#)" #)" #)" #)" !"
&ividend (.#)!! (.)8#) (.%)' (#.*** ('.!)@ ('.!)@
<oriJon value + &),-rs B g). + ' .$@%
Total E>s (.)8#) (.%)' (#.*** ('*.@*!%
PH of the E>s (.*#)8 (.8#8! (.@)** (#*.*8
Price + 0um of PHs + (#%.!)
++6 (10--) .on%onstant growth va"'ation ! G Answer: b 9A13
Cast dividend -&!. (.$)
0hortDrun growth rate #)"
CongDrun growth rate 8"
=e1uired return #"
6ear ! # '
#).!!" #).!!" 8.!!"
&ividend (.$)!! (#.@$) (#.$'** (#.@%@*
<oriJon value + &',-rs B g'. + *@ .'!$'
Total E>s (#.@$) ().!*$
PH of E>s (.%)' (*!.8%!
Price + 0um of PHs + (*#.8*
+,6 (10--) .on%onstant growth va"'ation ! G Answer: a 9A13
Cast dividend -&!. (.))
0hortDrun growth rate .)!"
CongDrun growth rate @.!!"
=e1uired return #.!!"
6ear ! # '
.)!" .)!" @.!!"
&ividend (.))!! (.)$'' (.)%8@ (.$#*8
<oriJon value + &',-rs B g'. + *' .*%
Total E>s (.)$'' (**.$@
PH of E>s (.*!*$ (').8*'%
Price + 0um of PHs + ('$.!)
+.6 (10--) .on%onstant growth va"'ation ! G Answer: $ 9A13
=e1uired return .!"
0hortDrun growth rate ).!"
CongDrun growth rate 8.!"
Cast dividend -&!. (.#)
6ear ! # ' *
&ividend (.#)!! (.*'$) (.8)' (.%! (#.!)#
<oriJon value + P# + &',-rs B g'. + *! .'!'#
Total E>s (.*'$) (.8)' (*#.#!*'
PH of E>s (.#%)! (.'*$ ('!.@)%*
Price + 0um of PHs + (''.)!
,/6 (10--) .on%onstant growth va"'ation ! G Answer: $ 9A13
=e1uired return + "
6ear ! # ' * ) 8
)!.!!" #).!!" @.!!"
&ividend (!.!!! (!.!!! (!.!!! (!.#)! (!.'$) (!.*8% (!.)!8
<oriJon value + P) + &8,-rs B g8. + 8.@$)
Total E>s (!.!!! (!.!!! (!.#)! (!.'$) ($.'**
PH of E>s (!.!!! (!.!!! (!.@' (!.#*$ (!.#%'
Price + (!.$#
,16 (10-/) !orporate va"'ation mo$e" ! G Answer: b 9A13
6ear # '
>ree cash flow D(#!.!! (*@.!! ()*.!!
GAEE + *.!!"
>irst, find the growth rate;
g + >E>',>E># B + #.)!!"
0econd, find the horiJon, or continuing, value, at 6ear #;
<H# + >E>',-GAEE / g. + (',8!!.!!
4ow find the PH of the >E>s and the horiJon value;
Total corporate value + >E>,-.*. 5 ->E># 5 <H#.,-.*.
#
+ (#,$@%.*$
,6 (10--) .on%onstant growth rate: ! G Answer: e ;E1Y 9A13
0toc2 price (*!.!!
Paid dividend -&!. (.!!
0hortDrun growth rate '!.!"
=e1uired return #.!"
>orecasted C= growth rate, 7 8.'*" Arbitrarily set at )" initially.
6ear ! # ' * )
'!.!" '!.!" '!.!" '!.!" 8.'*"
&ividend (.!!!! (.'!!! (.8%!! (#.%$! (#.@)8 ('.!'$#
<oriJon value + P* + &),-rs B g).; )' .8$$$
Total E>s (.'!!! (.8%!! (#.%$! ()8.)''@
PH of E>s (.8!$ (.'*$' (.)8'@ (').%#@#
0toc2 price + (*!.!! ?ust e1ual (*!. Ehange the forecasted growth rate till reach (*!.
Ge must solve for the longDrun growth rate. Ge can forecast the dividends in 6ears D*, so they are inserted in
the time line. Ge need a growth rate to find &) and the <H. Ge begin with a guess of say ).!", which we
insert in the forecast cell. Ge then find the PH of the forecasted E>s and sum them. Lf the sum e1uals the
given price, then our growth rate would be correct. Lf not, we need to substitute in different g's until we find
the one that wor2s. Ge used Excel's Foal 0ee2 function to simplify the process, but one could use trial and
error.
,!6 (10--) .on%onstant va"'ation--'se Ex%e":! G < Answer: $ ;E1Y 9A13
>inding the discount rate when we 2now the dividends and the actual stoc2 price is complicated if the growth rate
is not constant, and an iterative solution is re1uired.
Estimated rs + #.%$"
Actual ?ar2et Price, P!; ().!!
=apid Frowth 4ormal Frowth
6ear ! # ' * )
* )
&ividend growth rate !" !" !" )" )"
&ividends -&! has been paid. (.!! (.!! (.#! (.'' (.'%@
<H' + P' + &*,-rs / g*.. Mse Estimated rs. ($ .)#$
Total E>s (.!! (.#! (@.@)@
PHs of E>s discounted at Estimated rs (!.%$* (!.%*@ ('.!$@
Ealculated Price + P! + 0um of PHs + ().!!
,%6 (10A) Sto%& mar&et e2'i"ibri'm F G Answer: a EASY
,)6 (10A) Sto%& mar&et e2'i"ibri'm F G Answer: a EASY
,*6 (10A) Sto%& mar&et e2'i"ibri'm F G Answer: a EASY
,+6 (10A) Sto%& mar&et e2'i"ibri'm F G Answer: b EASY
Lf one condition holds, then the other must also hold.
,,6 (10A) +ar&et e2'i"ibri'm ! G Answer: b EASY
0tatement b is true, because if the expected return does not e1ual the re1uired return, then mar2ets are not in
e1uilibrium and buying,selling will occur until the expected return e1uals the re1uired return.
,.6 (10A) +ar&et e2'i"ibri'm ! G Answer: e +E345+

Stocks and Their Valuation Exercise

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(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)

. The preemptive right gives current stockholders the right to purchase,

6 (10-,) 1e2'ire$ ret'rn ! G Answer: b +E345+

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