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Problem Set 6

# Problem Set 6

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04/20/2014

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Washington State UniversityFinance 3251
Practice Problems
(Stock Valuation)
1. Michael’s, Inc. just paid \$1.40 to their shareholders as the annual dividend. Simultaneously,the company announced that future dividends will be increasing by 4.5 percent. If yourequire an 8 percent rate of return, how much are you willing to pay to purchase one shareof Michael’s stock?
2.
Angelina’s made two announcements concerning their common stock today. First, thecompany announced that their next annual dividend has been set at \$2.16 a share.Secondly, the company announced that all future dividends will increase by 4 percentannually. What is the maximum amount you should pay to purchase a share of Angelina’s stock if your goal is to earn a 10 percent rate of return?
3.
A stock pays a constant annual dividend and sells for \$31.11 a share. If the rate of return on this stock is 9 percent, what is the dividend amount?
4.
You have decided that you would like to own some shares of GH Corp. but need anexpected 12 percent rate of return to compensate for the perceived risk of such ownership.What is the maximum you are willing to spend per share to buy GH stock if the companypays a constant \$3.50 annual dividend per share?
5.
Turnips and Parsley common stock sells for \$39.86 a share at a market rate of return of 9.5 percent. The company just paid their annual dividend of \$1.20. What is the rate of growth of their dividend?
6.
B&K Enterprises will pay an annual dividend of \$2.08 a share on their common stock next week. Last year, the company paid a dividend of \$2.00 a share. The companyadheres to a constant rate of growth dividend policy. What will one share of B&Kcommon stock be worth ten years from now if the applicable discount rate is 8percent?
7.
The Red Bud Co. pays a constant dividend of \$1.20 a share. The company announcedtoday that they will continue to do this for another 3 years after which time they willdiscontinue paying dividends permanently. What is one share of this stock worth todayif the required rate of return is 7 percent?
8.
Bill Bailey and Sons pays no dividend at the present time. The company plans to startpaying an annual dividend in the amount of \$.30 a share for two years commencingtwo years from today. After that time, the company plans on paying a constant \$1 ashare dividend indefinitely. How much are you willing to pay to buy a share of thisstock if your required return is 14 percent?
9.
Lee Hong Imports paid a \$1.00 per share annual dividend last week. Dividends areexpected to increase by 5 percent annually. What is one share of this stock worth toyou today if the appropriate discount rate is 14 percent?

Washington State UniversityFinance 3252(Portfolio and CAPM)
10.
You want your portfolio beta to be 1.20. Currently, your portfolio consists of \$100invested in stock A with a beta of 1.4 and \$300 in stock B with a beta of .6. You haveanother \$400 to invest and want to divide it between an asset with a beta of 1.6 and arisk-free asset. How much should you invest in the risk-free asset?
11.
You have a \$1,000 portfolio which is invested in stocks A and B plus a risk-free asset.\$400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of .7.How much needs to be invested in stock B if you want a portfolio beta of .90?
12.
You recently purchased a stock that is expected to earn 12 percent in a booming economy, 8percent in a normal economy and lose 5 percent in a recessionary economy. There is a 15percent probability of a boom, a 75 percent chance of a normal economy, and a 10 percentchance of a recession. What is your expected rate of return on this stock?
13.
The Inferior Goods Co. stock is expected to earn 14 percent in a recession, 6 percent in anormal economy, and lose 4 percent in a booming economy. The probability of a boom is20 percent while the probability of a normal economy is 55 percent and the chance of arecession is 25 percent. What is the expected rate of return on this stock?
14.
You are comparing stock A to stock B. Given the following information, which one of these two stocks should you prefer and why?Rate of Return if State of Probability of State OccursEconomy State of Economy Stock A Stock BBoom 60% 9% 15%Recession 40% 4% -6%
15.
Zelo, Inc. stock has a beta of 1.23. The risk-free rate of return is 4.5 percent and the marketrate of return is 10 percent. What is the amount of the risk premium on Zelo stock?
16.
You own a portfolio with the following expected returns given the various states of theeconomy. What is the overall portfolio expected return?State of Probability of Rate of ReturnEconomy State of Economy if State OccursBoom 15% 18%Normal 60% 11%Recession 25% -10%
17.
What is the expected return on a portfolio which is invested 20 percent in stock A, 50percent in stock B, and 30 percent in stock C?State of Probability of Returns if State OccursEconomy State of Economy Stock A Stock B Stock CBoom 20% 18% 9% 6%Normal 70% 11% 7% 9%Recession 10% -10% 4% 13%

Washington State UniversityFinance 3253
18. What is the portfolio variance if 30 percent is invested in stock S and 70 percent isinvested in stock T?State of Probability of Returns if State OccursEconomy State of Economy Stock S Stock TBoom 40% 12% 20%Normal 60% 6% 4%19. What is the standard deviation of a portfolio that is invested 40 percent in stock Q and 60percent in stock R?State of Probability of Returns if State OccursEconomy State of Economy Stock Q Stock RBoom 25% 18% 9%Normal 75% 9% 5%
20.
Your portfolio has a beta of 1.18. The portfolio consists of 15 percent U.S. Treasury bills,30 percent in stock A, and 55 percent in stock B. Stock A has a risk-level equivalent to thatof the overall market. What is the beta of stock B?21. You would like to combine a risky stock with a beta of 1.5 with U.S. Treasury bills in sucha way that the risk level of the portfolio is equivalent to the risk level of the overall market.What percentage of the portfolio should be invested in Treasury bills?
22.
The market has an expected rate of return of 9.8 percent. The long-term governmentbond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4percent. The inflation rate is 3.1 percent. What is the market risk premium?
23.
The risk-free rate of return is 4 percent and the market risk premium is 8 percent. Whatis the expected rate of return on a stock with a beta of 1.28?24. The common stock of Flavorful Teas has an expected return of 14.4 percent. Thereturn on the market is 10 percent and the risk-free rate of return is 3.5 percent. Whatis the beta of this stock?25. Which one of the following stocks is correctly priced if the risk-free rate of return is3.6 percent and the market rate of return is 10.5 percent?Stock Beta Expected ReturnA .85 9.2%B 1.08 11.8%C 1.69 15.3%D .71 7.8%E 1.45 12.3%