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# Chapter 3 Multiple Choice Questions 1.

Present Value is defined as: A) Future cash flows discounted to the present at an appropriate discount rate B) Inverse of future cash flows C) Present cash flow compounded into the future D) None of the above Answer: A Type: Easy Page: 33

2. The present value of \$100 expected in two years from today at a discount rate of 10% is: A) \$90.91 B) \$110.00 C) \$100.00 D) \$82.64 E) None of the above Answer: D Type: Easy Page: 33 Response: PV = 100 / (1.1^2) = 82.64 3. If the interest rate is 15%, what is the 2- year discount factor? A) 0.7561 B) 0.8697 C) 1.3225 D) None of the above Answer: A Type: Easy Page: 33 Response: DF = 1 / (1.15^2) = .7561 4. The absence of money machines means there are: A) No opportunities for arbitrage B) No opportunities for investment C) No opportunities for borrowing D) All of the above Answer: A Type: Medium Page: 34

5. If the 2-year discount factor is 0.5102, what is the rate of interest (in APR)? A) 10% B) 25% C) 40% D) None of the above. Answer: C Type: Medium Page: 34 Response: 0.5102 = 1/(1+r)^2; (1+r)^2 = 1.96; 1+r = 1.40; r = 40% 6. If the present value of the cash flow X is \$200, and the present value cash flow Y \$150, than the present value of the combined cash flow is: A) \$200 B) \$150 C) \$50 D) \$350 E) None of the above Answer: D Type: Easy Page: 34 Response: PV (x + y) = PV (x) + PV (y) = 200 + 150 = 350 7. What is the present value of the following cash flow at a 12% discount rate?
Y e a r 1 Y e a r 2 Y e a r 3 \$ 1 0 0 , 0 0 0 \$ 1 5 0 , 0 0 0 \$ 2 0 0 , 0 0 0

A) B) C) D)

## Answer: A Type: Medium Page: 34 Response: PV = (100,000/1.12) + (150,000/(1.12^2)) + 200,000/(1.12^3) = 351,221

8. 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) B) C) D)

## \$101,221 \$200,000 \$142,208 None of the above

Answer: A Type: Medium Page: 34 Response: NPV = -250,000 + (100,000/1.12) + (150,000/(1.12^2)) + 200,000/(1.12^3) = 101,221 9. What is the present value of the following cash flow at a discount rate of 12% APR?
t = 1 t = 2 1 0 0 , 0 0 03 0 0 , 0 0 0

A) B) C) D)

## \$185,000 \$200,000 \$149,872 None of the above

Answer: C Type: Medium Page: 34 Response: PV = (-100,000/1.12) + (300,000/(1.12^2)) = 149,872 10. What is the net present value of the following cash flow at a discount rate of 15%?
t = 0 t = 1 t = 2 1 2 0 , 0 0 0 3 0 0 , 0 0 0 1 0 0 , 0 0 0

A) B) C) D)

## \$65,255 \$80,000 \$26,300 None of the above

Answer: A Type: Medium Page: 34 Response: NPV = -120,000 + (300,000/1.15) - (100,000/(1.15^2)) = 65,255

11. A perpetuity is defined as: A) Equal cash flows at equal intervals of time forever B) Equal cash flows at equal intervals of time for a specific period C) Unequal cash flows at equal intervals of time forever D) None of the above Answer: A Type: Easy Page: 37

12. What is the present value of \$10,000 per year perpetuity at an interest rate of 5%? A) \$10,000 B) \$100,000 C) \$200,000 D) None of the above Answer: C Type: Easy Page: 37 Response: PV = (10,000/0.05) = 200,000 13. You would like to have enough money saved to receive a \$60,000 per year perpetuity 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) \$750,000 C) \$600,000 D) None of the above Answer: C Type: Medium Page: 37 Response: PV = (60,000/0.1) = 600,000

Response: PV = (3.791 3.170)*(1) = 0.621 21. If the three-year present value annuity factor is 2.723 and two-year present value annuity factor is 1.859, what is the present value of \$1 received at the end of the 3 years? A) \$0.157 B) \$0.864 C) \$1.00 D) None of the above Answer: B Type: Difficult Page: 39 Response: PV = (2.723-1.859) *(1) = 0.864 22. What is the present value annuity factor at a discount rate of 13% for 10 years? A) \$5.4262 B) \$8.514 C) \$8.13 D) None of the above Answer: A Type: Medium Page: 39 Response: PV annuity factor = (1/0.13) (1/((0.13)(1.13^10))) = 5.4262 23. What is the present value annuity factor at an interest rate of 11% for 5 years? A) 8.514 B) 6.145 C) 3.6959 D) None of the above Answer: C Type: Medium Page: 39 Response: PV annuity factor = (1/0.11) (1/((0.11)(1.11^5))) = 3.6959 24. What is the present value of \$1000 per year annuity for ten years at an interest rate of 10%? A) \$6145 B) \$8514 C) \$2594 D) None of the above Answer: A Type: Medium Page: 39 Response: PV annuity factor = [(1/0.10) (1/((0.10)(1.10^ 10)))]*1000 = 6145 25. What is the present value of \$2000 per year annuity at a discount rate of

15% for 15 years? A) \$8,137 B) \$11,695 C) \$17,028 D) None of the above Answer: B Type: Medium Page: 39 Response: PV = [(1/0.15) (1/((0.15)(1.15^15)))]*2000 = 11,695 26. After retirement, you expect to live for 20 years. You would like to have \$80,000 income each year. How much should you have saved in the retirement to receive this income, if the interest is 10% per year (assume that the payments start one years after the retirement)? A) \$681,085 B) \$1,600,300 C) \$538,200 D) None of the above Answer: A Type: Difficult Page: 39 Response: PV = [(1/0.10) (1/((0.10)(1.10^20)))]*80,000 = 681,085 27. After retirement, you expect to live for 20 years. You would like to have \$80,000 income each year. How much should you have saved in the retirement to receive this income, if the interest is 10% per year (assume that the payments start on the day of retirement)? A) \$681,085 B) \$749,194 C) \$538,200 D) None of the above Answer: B Type: Difficult Page: 39 Response: PV = [[(1/0.10) (1/((0.10)(1.10^20)))]*80,000]*(1.1) = 749,194. 28. If the present annuity factor is 3.89, what is the present value annuity factor for an equivalent annuity due if the interest rate is 9%? A) 3.57 B) 4.24 C) 3.89 D) None of the above. Answer: B Type: Difficult Page: 39 Response: annuity due factor = 3.89 * 1.09 = 4.24

29. If the present value annuity factor for 10 years at 10% interest rate is 6.71, what is the present value annuity factor for an equivalent annuity due? A) 7.38 B) 6.10 C) 6.71 D) None of the above Answer: A Type: Difficult Page: 39 Response: Annuity due: 6.71 * 1.1 = 7.38 30. John House has taken a \$150,000 mortgage on his house at an interest rate of 7% per year. If the mortgage calls for twenty equal annual payments, what is the amount of each payment? A) \$14,158.94 B) \$10,500.00 C) \$16,882.43 D) None of the above Answer: A Type: Difficult Page: 39 Response: (Use a financial calculator) PV = 150,000; I -= 7%; N = 20; FV = 0; Compute PMT = \$14,158.94 31. John House has taken a \$150,000 mortgage on his house at an interest rate of 7% per year. What is the value of the mortgage after the payment of the fifth annual installment? A) \$128,958.41 B) \$479,205.30 C) \$97,500.00 D) None of the above Answer: A Type: Difficult Page: 39 Response: 150,000/10.594 = 14,158.94; 14,158.94(9.1070) = \$128,958.41 32. If the present value of \$1.00 received n years from today at an interest rate of r is 0.621, then what is the future value of \$1.00 invested today at an interest rate of r% for n years? A) \$1.00 B) \$1.61 C) \$1.70 D) Not enough information to solve the problem Answer: B Type: Difficult Page: 40 Response: FV = 1/(0.621) = 1.61

33. If the present value of \$1.00 received n years from today at an interest rate of r is 0.270, then what is the future value of \$1.00 invested today at an interest rate of r% for n years? A) \$1.00 B) \$3.70 C) \$1.70 D) Not enough information to solve the problem Answer: B Type: Difficult Page: 40 Response: FV = 1/(0.270) = 3.70 34. If the future value of \$1 invested today at an interest rate of r% for n years is 2.5937, what is the present value of \$1 to be received in n years at r% interest rate? A) \$0.3855 B) \$1.00 C) \$0.621 D) None of the above Answer: A Type: Difficult Page: 40 Response: PV = 1/2.5937 = 0.38555 35. If the present value annuity factor at 12% APR for 5 years is 3.605, what is the equivalent future value annuity factor? A) 6.353 B) 2.046 C) 1.762 D) None of the above Answer: A Type: Difficult Page: 40 Response: FV annuity factor = 3.605*(1.12^5) = 6.353 36. If the future value annuity factor at 10% and 5 years is 6.1051, calculate the equivalent present value annuity factor A) 6.1051 B) 3.7908 C) 9.8323 D) none of the given ones Answer: B Type: Difficult Page: 40 Response: PV = 6.1051/(1.1)^5 = 3.7908

37. If the present value annuity factor at 8% APR for 10 years is 6.71, what is the equivalent future value annuity factor? A) 3.108 B) 14.486 C) 2.159 D) None of the above Answer: B Type: Difficult Page: 40 Response: FV annuity factor = 6.21*(1.08^5) = 14.486 38. If the present value annuity factor at 10% APR for 10 years is 6.1446, what is the equivalent future value annuity factor? A) 3.108 B) 15.9374 C) 2.159 D) None of the above Answer: B Type: Difficult Page: 40 Response: FV annuity factor = 6.21*(1.08^5) = 14.486 39. Which of the following statements is true? A) Present value of an annuity due is always less than the present value of an equivalent annuity factor for a given interest rate B) The present value of an annuity approaches the present value of a perpetuity as n goes to infinity for a given interest rate C) Both A and B are true D) Both A and B are false Answer: B Type: Difficult Page: 40

40. Which of the following statements is true? A) Present value of an annuity is always greater than the present value of equivalent annuity for a given interest rate. B) The future value of an annuity factor is always greater than the future value of an equivalent annuity at the same interest rate. C) Both A and B are true D) Both A and B are false Answer: C Type: Difficult Page: 40

41. Mr. Hopper is expected to retire in 30 years and he wishes accumulate \$1,000,000 in his retirement fund by that time. If the interest rate is 12% per

year, how much should Mr. Hopper put into the retirement fund each year in order to achieve this goal? A) \$4,143.66 B) \$8,287.32 C) \$4,000 D) None of the above Answer: A Type: Difficult Page: 40 Response: Future value annuity factor = [(1/0.12) (1/(0.12*1.12^30)]*(1.12^30) = 241.3827; payment = 1,000,000/241.3327 = 4143.66 42. Mr. Hopper is expected to retire in 30 years and he wishes accumulate \$750,000 in his retirement fund by that time. If the interest rate is 10% per year, how much should Mr. Hopper put into the retirement fund each year in order to achieve this goal? A) \$4,559.44 B) \$2,500 C) \$9,118.88 D) None of the above Answer: A Type: Difficult Page: 40 Response: Future value annuity factor = [(1/0.10) (1/(0.10*1.10^30)]*(1.10^30) = 164.494; payment = 750,000/164.494 = 4559.44 43. If you invest \$100 at 12% APR for three years, how much would you have at the end of 3 years using simple interest? A) \$136 B) \$140.49 C) \$240.18 D) None of the above Answer: A Type: Medium Page: 40 Response: FV = 100 + (100*0.12*3) = \$136 44. If you invest \$100 at 12% APR for three years, how much would you have at the end of 3 years using compound interest? A) \$136 B) \$140.49 C) \$240.18 D) None of the above Answer: B Type: Medium

Page: 40 Response: FV = 100*(1.12^3) = \$140.49 45. Which of the following statements regarding simple interest and compound interest are true? A) Problems in finance generally use the simple interest concept B) Problems in finance generally use the compound interest concept C) It does not really matter whether you use simple interest or compound interest for solving problems in finance D) None of the above Answer: B Type: Medium Page: 40

46. Which of the following statements is true? A) The process of discounting is the inverse of the process of compounding B) Ending balances using simple interest is always greater than the ending balance using compound interest at positive interest rates. C) Present value of an annuity due is always less than the present value of an equivalent annuity at positive interest rates D) All of the above are true Answer: A Type: Difficult Page: 41

47. John House has just taken out a \$150,000 mortgage at an interest rate of 8% per year. If the mortgage calls for equal monthly payments for twenty years, what is the amount of each payment? (Assume monthly compounding or discounting.) A) \$1254.70 B) \$1625.00 C) \$1263.06 D) None of the above are true Answer: A Type: Difficult Page: 43 Response: PMT = 150,000/[(1/0.006667) 1/((0.006667*((1+.006667)^240)))] = \$1254.70 48. Mr. Anton expects to retire in 30 years and would like to accumulate \$1 million in the pension fund. If the annual interest rate is 12% per year, how much should Mr. Anton put into the pension fund each month in order to achieve his goal? Assume that Mr. Anton will deposit the same amount each month into his pension fund and also use monthly compounding. A) \$286.13 B) \$771.60 C) \$345.30 D) None of the above

Answer: A Type: Difficult Page: 43 Response: PMT = 1,000,000/ {[(1/0.01)-(1/(0.01*(1.01^360)))]*(1.01^360)}= \$286.13 49. An investment at 12% nominal rate compounded monthly is equal to an annual rate of: A) 12.68% B) 12.36% C) 12% D) None of the above Answer: A Type: Medium Page: 43 Response: EAR = ((1.01)^12)-1 = 0.12681 = 12.68% 50. An investment at 10.47% effective rate compounded monthly is equal to a nominal (annual) rate of: A) 10.99% B) 9.57% C) 10% D) None of the above Answer: C Type: Medium Page: 43 Response: NOM = [((1.1047)^(1/12)-1]*12 = 0.1 = 10.00% 51. An investment at 10% nominal rate compounded continuously is equal to an equivalent annual rate of: A) 10.250% B) 10.517% C) 10.381% D) None of the above Answer: B Type: Difficult Page: 43 Response: (e^(0.1))-1 = 0.10517 = 10.517% 52. The present value of a \$100 per year perpetuity at 10% per year interest rate is \$1000. What would be the present value if the payments were compounded continuously? A) \$1000.00 B) \$1049.21 C) \$1024.40 D) None of the above

Answer: B Type: Difficult Page: 43 Response: (e^r) = 1.1r = ln(1.1) = 0.09531; PV = 100/0.09531 = \$1049.21 53. If the nominal interest rate per year is 10% and the inflation rate is 4%, what is the real rate of interest? A) 10% B) 4% C) 5.8% D) None of the above Answer: C Type: Easy Page: 46 Response: 1+rreal = (1+rnominal)/(1+rinflation) = 1.1/1.04 =1.058; rreal = 5.8% 54. Mr. X invests \$1000 at 10% nominal rate for one year. If the inflation rate is 4%, what is the real value of the investment at the end of one year? A) \$1100 B) \$1000 C) \$1058 D) None of the above Answer: C Type: Medium Page: 46 Response: Real investment = (1000*1.1)/(1.04) = \$1058 55. A 5-year treasury bond with a coupon rate of 8% has a face value of \$1000. What is the annual interest payment? A) \$80 B) \$40 C) \$100 D) None of the above Answer: A Type: Easy Page: 47 Response: Annual interest payment = 1000(0.08) = \$80 56. A 3-year bond with 10% coupon rate and \$1000 face value yields 8% APR. Assuming annual coupon payment, calculate the price of the bond. A) \$1051.54 B) \$951.96 C) \$1000.00 D) \$857.96 Answer: A

Type: Medium Page: 47 Response: PV = (100/1.08) + (100/(1.08^2)) + (1100/(1.08^3)) = \$1051.54 57. A three-year bond has 8.0% coupon rate and face value of \$1000. If the yield to maturity on the bond is 10%, calculate the price of the bond assuming that the bond makes semi-annual coupon interest payments. A) \$949.24 B) \$857.96 C) \$1057.54 D) \$1000.00 Answer: A Type: Difficult Page: 47 Response: PV = (40/1.05) + (40/(1.05^2)) +. . . + (1040/(1.05^6)) = \$949.24 58. A four-year bond has an 8% coupon rate and a face value of \$1000. If the current price of the bond is \$878.31, calculate the yield to maturity of the bond (assuming annual interest payments). A) 8% B) 12% C) 10% D) 6% Answer: B Type: Difficult Page: 48 Response: Use trial and error method. (80/1.12) + (80/(1.12^2)) + (80/(1.12^3)) + (1180/(1.12^4)) = \$870.51. Therefore, yield to maturity is 12%. Or use a financial calculator: PV = -878.31; N = 4; PMT = 80; FV = 1000; COMPUTE: I = 12% Chapter 4 The Value of Common Stocks Multiple Choice Questions 1. If the Vol. 100s is reported as 10,233 in the Wall Street Journal quotation, then the trading volume for that day of trading is: A) 10,233 shares B) 102,330 shares C) 1,023,300 shares D) 10,233,000 shares Answer: C Type: Medium Page: 60 Response: Trading volume = 10,233 * 100 = 1,023,300

2. The dividend yield reported as Yld. % in The Wall Street Journal quotation is calculated as follows: A) (dividends / hi) B) (dividends / lo) C) (dividends / close) D) None of the above Answer: C Type: Medium Page: 60

3. The Wall Street Journal quotation for a company has the following values: Div: 2.28, PE: 19, Close: 75.30. Calculate the dividend pay out ratio for the company. A) 58% B) 12% C) 75% D) None of the above Answer: A Type: Difficult Page: 60 Response: EPS = (75.30)/19 = 3.9631 dividend payout = 2.28/3.9631 = 0.5753= 58% 4. If the Wall Street Journal Quotation for a company has the following values close: 26.00; Net chg: =+1.00; then the closing price for the stock for the previous trading day was? A) \$26 B) \$25 C) \$27 D) None of the above. Answer: B Type: Medium Page: 60 Response: Previous closing = today's closing net chg. = 26.00-1.00= \$25.00 5. The value of a common stock today depends on: A) Number of shares outstanding and the number of shareholders B) The Wall Street analysts C) The expected future dividends and the discount rate D) Present value of the future earnings per share Answer: C Type: Easy Page: 62

6. Super Computer Company's stock is selling for \$100 per share today. It is expected that this stock will pay a dividend of 5 dollars per share, and then be

sold for \$120 per share at the end of one year. Calculate the expected rate of return for the shareholders. A) 20% B) 25% C) 10% D) 15% Answer: B Type: Easy Page: 62 Response: r = (120+5-100)/100 = 25% 7. PC Company stockholders expect to receive a year-end dividend of \$10 per share and then be sold for \$122 dollars per share. If the required rate of return for the stock is 20%, what is the current value of the stock? A) \$100 B) \$122 C) \$132 D) \$110 Answer: D Type: Medium Page: 62 Response: P = (122+10)/1.2 = 110 8. Macrohard Company expects to pay a dividend of \$6 per share at the end of year one, \$8 per share at the end of year two and then be sold for \$136 per share. If the required rate on the stock is 20%, what is the current value of the stock? A) \$100 B) \$105 C) \$110 D) \$120 Answer: B Type: Medium Page: 62 Response: P = (6/1.2)+(8+136)/(1.2^2) = 105 9. The constant dividend growth formula P0 = D1/(r-g) assumes: A) The dividends are growing at a constant rate g forever. B) r > g C) g is never negative. D) Both A and B Answer: D Type: Medium Page: 64

10. Casino Co. is expected to pay a dividend of \$6 per share at the end of year one and these dividends are expected to grow at a constant rate of 8% per year

forever. If the required rate of return on the stock is 20%, what is current value of the stock today? A) \$30 B) \$50 C) \$100 D) \$54 Answer: B Type: Medium Page: 64 Response: P = (6/(0.2-0.08) = 50 11. WorldTour Co. has just now paid a dividend of \$6 per share (Do), the dividends are expected to grow at a constant rate of 5% per year forever. If the required rate of return on the stock is 15%, what is the current value on stock, after paying the dividend? A) \$63 B) \$56 C) \$40 D) \$48 Answer: A Type: Medium Page: 64 Response: P = (6*1.05)/(0.15 0.05) = 63 12. The required rate of return or the market capitalization rate is estimated as follows: A) Dividend yield + expected rate of growth in dividends B) Dividend yield - expected rate of growth in dividends C) Dividend yield / expected rate of growth in dividends D) (Dividend yield) * (expected rate of growth in dividends) Answer: A Type: Difficult Page: 65

13. Mcom Co. is expected to pay a dividend of \$4 per share at the end of year one and the dividends are expected to grow at a constant rate of 4% forever. If the current price of the stock is \$25 per share calculated the required rate of return or the market capitalization rate for the firms' stock. A) 4% B) 16% C) 20% D) None of the above. Answer: C Type: Medium Page: 65 Response: r = (4/25) + 0.04 = 20%

14. Dividend growth rate for a stable firm can be estimated as: A) Plow back rate * the return on equity (ROE) B) Plow back rate / the return on equity (ROE) C) Plow back rate +the return on equity (ROE) D) Plow back rate - the return on equity (ROE) Answer: A Type: Difficult Page: 66

15. MJ Co. pays out 60% of its earnings as dividends. Its return on equity is 20%. What is the stable dividend growth rate for the firm? A) 3% B) 5% C) 8% D) 12% Answer: C Type: Difficult Page: 66 Response: g = (1 - 0.6)*20 = 8% 16. Michigan Motor Company is currently paying a dividend of \$1.50 per year. The dividends are expected to grow at a rate of 20% for the next three years and then a constant rate of 6 % thereafter. What is the expected dividend per share in year 5? A) \$2.59 B) \$2.00 C) \$2.91 D) \$1.50 Answer: C Type: Medium Page: 69 Response: D5 = (1.5) * (1.2^3) * (1.06^2) = 2.91 17. Great Lakes Co. is currently paying a dividend of \$2.20 per share. The dividends are expected to grow at 25% per year for the next four years and then grow 5% per year thereafter. Calculate the expected dividend in year 6. A) \$5.37 B) \$2.95 C) \$5.92 D) \$8.39 Answer: A Type: Medium Page: 69 Response: Div6=2.2 * (1.25^4) * (1.05^2) = 5.92

18. Y2K Technology Corporation has just paid a dividend of \$0.40 per share. The dividends are expected to grow at 30% per year for the next two years and at 5% per year thereafter. If the required rate of return in the stock is 15% (APR), calculate the current value of the stock. A) \$1.420 B) \$6.33 C) \$5.63 D) None of the above Answer: B Type: Difficult Page: 69 Response: Po = [(0.4 *1.3)/1.15] + [(0.4 * 1.3^2)/(1.15^2)] + [(0.4 * 1.3^2*1.06)/((1.15^2 * (0.15 0.05))] = \$6.33 19. The NetTech Co. has just paid a dividend of \$1 per share. The dividends are expected to grow at 20% per year for the next three years and at the rate of 5% per year thereafter. If the required rate of return on the stock is 15%(APR), what is the current value of the stock? A) \$18.14 B) \$15.20 C) \$12.51 D) None of the above Answer: B Type: Difficult Page: 69 Response: P = (1.2/1.15) + (1.44/1.15^2) + (1.728/1.15^3) + (1.8144/((1.15^3) * (0.15 0.05)) = 15.20 20. Lake Co. has paid a dividend \$2 per share out of earnings of \$4 per share. If the book value per share is \$25, what is the expected growth rate in dividends (g)? A) 16% B) 12% C) 8% D) 4% Answer: C Type: Difficult Page: 72 Response: g = (1 0.5) (4/25) = 0.08 or 8% 21. Lake Co. has paid a dividend \$2 per share out of earnings of \$4 per share. If the book value per share is \$25 and is currently selling for \$30 per share, calculate the required rate of return on the stock. (Use the calculated g from the previous problem to answer this question.) A) 7.2% B) 15.2% C) 14.7% D) 16.6%

Answer: B Type: Difficult Page: 72 Response: g = (1 0.5)(4/25) = 0.08 or 8%; [(2*1.08)/30] + 0.08 = 15.2 %. 22. Lake Co. has paid a dividend \$3 per share out of earnings of \$5 per share. If the book value per share is \$40, what is the expected growth rate in dividends? A) 12.5% B) 8% C) 5% D) 3% Answer: C Type: Difficult Page: 72 Response: g = (1 (5/40) = .05 or 5%; 23. Lake Co. has paid a dividend \$3 per share out of earnings of \$5 per share. If the book value per share is \$40 and the share value is 52.50 per share, calculate the required rate of return on the stock. (Use the calculated 'g' from the previous problem to answer this question) A) 11% B) 12% C) 5% D) 6% Answer: A Type: Difficult Page: 72 Response: g = (1 0.6) (5/40) = .05 or 5%; [(3*1.05)/52.50] + 0.05 = 0.11 = 11%. 24. The growth rate in dividends can be thought of as a sum of two parts. They are: A) ROE and the Retention Ratio. B) Dividend yield and growth rate in dividends C) ROA and ROE D) Book value per share and EPS Answer: A Type: Medium Page: 72 25. The value of the stock: A) Increases as the dividend growth rate increases B) Increases as the required rate of return decreases C) Increases as the required rate of return increases D) Both A and B Answer: D Type: Difficult

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26. Company X has a P/E ratio of 10 and a stock price of \$50 per share. Calculate earnings per share of the company. A) \$5 per share B) \$10 per share C) \$0.20 per share D) \$6 per share Answer: A Type: Medium Page: 74 Response: EPS = 50/10 = \$5 27. Companies with higher expected growth opportunities usually sell for: A) Lower P/E ratio B) Higher P/E ratio C) A price that is independent of P/E ratio D) A price that the dependent upon the payment ratio Answer: B Type: Medium Page: 74

28. Which of the following formulas regarding earnings to price ratio is true: A) EPS/Po = r[1+(PVGO/Po] B) EPS/Po = r[1 - (PVGO/Po)] C) EPS/Po = [r+(PVGO/Po)] D) EPS/Po =[r(1+(PVGO/Po)]/r Answer: B Type: Difficult Page: 74

29. Woe Co. is expected to pay a dividend or \$4.00 per share out of earnings of \$7.50 per share. If the required rate of return on the stock is 15% and dividends are growing at a current rate of 10% per year, calculate the percent value of the growth opportunity for the stock (PVGO). A) \$80 B) \$50 C) \$30 D) \$26 Answer: C Type: Difficult Page: 74 Response: No growth value = 7.5/0.15 = 50; Po = 4/ (0.15-0.1) = 80; PVGO = 8050 = 30 30. Parcel Corporation is expected to pay a dividend of \$5 per share next year, and the dividends pay out ratio is 50%. If the dividends are expected to grow at a constant rate of 8% forever and the required rate of return on the stock is 13%, calculate the present value of the growth opportunity. A) \$23.08 B) \$64.10 C) \$100 D) None of the above Answer: A Type: Difficult Page: 74 Response: EPS= (5/0.5)=\$10; No Growth Value = 10/0.13 = 76.92; Growth Value = 5/(0.13-0.08) = 100; PVGO = 100-76.92 = 23.08 31. A high proportion of the value a growth stock comes from: A) Past dividend payments B) Past earnings C) PVGO (Present Value of the Growth Opportunities) D) Both A and B Answer: C Type: Medium Page: 74

32. Generally high growth stocks pay: A) High dividends B) Low or no dividends C) Erratic dividends D) Both A and C Answer: B Type: Medium Page: 74

33. The following stocks are examples of growth stocks except: A) Wal-Mart B) Dell Computer C) Microsoft D) Chubb Answer: D Type: Medium Page: 74

34. The following stocks are examples of income stocks except: A) Exxon Mobil B) Wal-Mart C) Chubb D) Kellogg E) All of the above Answer: B Type: Easy Page: 74

35. Which of the following stocks are growth stocks? A) Dell Computer B) AT&T C) Duke Power D) Exxon E) None of the above Answer: A Type: Easy Page: 74

36. Which of the following stocks are income stocks? A) Duke Power B) Dell Computer C) Microsoft D) Wal-Mart E) None of the above Answer: A Type: Easy Page: 74 37. The relationship between P/E ratio and market capitalization rate can be described by the following statements: A) EPS/Po measures r, only if PVGO = 0 B) High P/E ratios indicate low r C) There is no reliable association between the P/E ratio and r D) A and C above

## Answer: D Type: Easy Page: 75

38. Universal Air is a no growth firm and has two million shares outstanding. It is expected to earn a constant 20 million per year on its assets. If all earnings are paid out as dividends and the cost of capital is 10%, calculate the current price per share for the stock. A) \$200 B) \$100 C) \$150 D) \$50 Answer: B Type: Medium Page: 77 Response: EPS = DPS = 20/2 = \$10 per share = Po = 10/0.1 = 100 39. Which of the following statements regarding free cash flow is true? A) Free cash flow is always positive B) Free cash flow is always negative C) Free cash flow is the net cash flow to the shareholders after paying for future investments D) None of the above Answer: C Type: Medium Page: 77

40. Discounted cash flow formulas work for the valuation of: A) Stocks with constant dividend growth B) Businesses C) Stocks with super normal dividend growth D) All of the above Answer: D Type: Medium Page: 77

41. The value of a business is given by: A) PV = PV(free cash flows) B) PV = PV(free cash flows) + PV (horizon value) C) PV(free cash flows) PV(horizon value) D) None of the above Answer: B Type: Medium Page: 77

42. The present value of free cash flow is \$5 million and the present value of the horizon value is \$10 million. Calculate the present value of the business. A) \$5 million B) \$10 million C) \$15 million D) None of the above Answer: C Type: Medium Page: 77 Response: PV(business) = 5 + 10 = 15