Chapter 008 Stock Valuation: Aacsb Topic: Analytic SECTION: 8.1 Topic: Stock Value Type: Problems

Chapter 008 Stock Valuation
58. Gerold's Travel Service just paid $1.79 to its shareholders as the annual dividend.
Simultaneously, the company announced that future dividends will be increasing by 3.2
percent. If you require a 10.5 percent rate of return, how much are you willing to pay to
purchase one share of this stock?
a. $17.59
b. $20.64
c. $24.08
d. $24.52
E. $25.31
AACSB TOPIC: ANALYTIC

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
8-1
59. Jessica's Pharmacy made two announcements concerning their common stock today. First,
the company announced the next annual dividend will be $1.48 a share. Secondly, all
dividends after that will increase by 2.5 percent annually. What is the maximum amount you
should pay to purchase a share of this stock if your goal is to earn a 12 percent rate of return?
a. $12.33
b. $12.64
c. $13.27
D. $15.58
e. $15.97

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
60. How much are you willing to pay for one share of Delphia stock if the company just paid
a $1.34 annual dividend, the dividends increase by 2.8 percent annually, and you require a 14
percent rate of return?
a. $9.84
b. $11.96
C. $12.30
d. $12.99
e. $13.61

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
8-2
61. Textile Importers paid a $1.60 per share annual dividend last week. Dividends are
expected to increase by 4 percent annually. What is one share of this stock worth to you today
if your required rate of return is 13.5 percent?
a. $16.84
B. $17.52
c. $19.23
d. $19.87
e. $20.59

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
62. Elegante Homes stock traditionally provides a 16 percent rate of return. The company just
paid an annual dividend of $3.20 a share and is expected to increase that amount by 5 percent
per year. If you are planning to buy 1,000 shares of this stock next year, how much should
you expect to pay per share if the market rate of return for this type of security is 9 percent at
the time of your purchase?
a. $30.55
b. $32.07
c. $67.20
d. $80.00
E. $88.20

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
8-3
63. The Good Life offers a common stock that pays an annual dividend of $2 a share. The
company has promised to maintain a constant dividend. How much are you willing to pay for
one share of this stock if you want to earn a 9 percent return on your equity investments?
A. $22.22
b. $24.22
c. $26.67
d. $28.57
e. $31.14

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
64. The Row Boat has paid annual dividends of $.48, $0.60, and $0.62 a share over the past
three years, respectively. The company now predicts that it will maintain a constant dividend
since its business has leveled off and sales are expected to remain relatively constant. Given
the lack of future growth, you will only buy this stock if you can earn at least a 14 percent rate
of return. What is the maximum amount you are willing to pay for one share of this stock
today?
a. $3.43
b. $4.29
C. $4.43
d. $5.05
e. $5.60

SECTION: 8.1
TOPIC: STOCK VALUE
TYPE: PROBLEMS
8-4
65. The common stock of BJ's Auto Clinic sells for $38.25 a share. The stock is expected to
pay $1.90 per share next month when the annual dividend is distributed. BJ's has established a
pattern of increasing their dividends by 2.5 percent annually and expects to continue doing so.
What is the market rate of return on this stock?
a. 4.41 percent
b. 4.97 percent
c. 7.38 percent
D. 7.47 percent
e. 7.59 percent

SECTION: 8.1
TOPIC: REQUIRED RETURN
TYPE: PROBLEMS
66. The current yield on Martin's Mills common stock is 3.6 percent. The company just paid a
$1.80 dividend and plans to pay $1.86 next year. The dividend growth rate is expected to
remain constant at the current level. What is the required rate of return on this stock?
a. 3.72 percent
b. 4.08 percent
c. 5.69 percent
d. 6.93 percent
E. 7.05 percent

SECTION: 8.1
TYPE: PROBLEMS
8-5
67. Lake Shore Vineyards recently paid a $4.20 annual dividend on their common stock. This
dividend increases at an average rate of 4.2 percent per year. The stock is currently selling for
$80.65 a share. What is the market rate of return?
a. 5.21 percent
b. 5.43 percent
c. 5.67 percent
d. 9.41 percent
E. 9.63 percent

SECTION: 8.1
TYPE: PROBLEMS
68. Alaskan Foodstuffs just announced the annual dividend for this coming year will be $0.36
a share and all future dividends are expected to increase by 4.5 percent annually. What is the
market rate of return if the stock is currently selling for $12.20 a share?
A. 7.45 percent
b. 7.58 percent
c. 7.67 percent
d. 7.92 percent
e. 8.00 percent

SECTION: 8.1
TYPE: PROBLEMS
8-6
69. Shares of common stock of the Windy Farms offer an expected total return of 13.8
percent. The dividend is increasing at a constant 4.2 percent per year. What is the dividend
yield?
a. 8.70 percent
B. 9.60 percent
c. 12.2 percent
d. 15.5 percent
e. 18.0 percent
Dividend yield = .138 .042 = 9.6 percent

SECTION: 8.1
TOPIC: DIVIDEND YIELD
TYPE: PROBLEMS
70. The common stock of Jesup's returned a nifty 24.6 percent rate of return last year. The
dividend amount was $0.40 a share which equated to a dividend yield of 0.6 percent. What
was the rate of price appreciation for the year?
a. 18.6 percent
B. 24.0 percent
c. 24.6 percent
d. 25.2 percent
e. 30.6 percent
g = .246 .006 = .24 = 24.0 percent

SECTION: 8.1
TOPIC: CAPITAL GAIN
TYPE: PROBLEMS
8-7
71. RTF, Inc. common stock sells for $22 a share and pays an annual dividend that increases
by 3.8 percent annually. The market rate of return on this stock is 8.2 percent. What is the
amount of the last dividend paid?
a. $0.88
b. $0.90
C. $0.93
d. $0.97
e. $1.00

SECTION: 8.1
TOPIC: DIVIDEND AMOUNT
TYPE: PROBLEMS
72. The common stock of Flo's Flowers pays an annual dividend that is expected to increase
by 3.6 percent per year. The stock commands a market rate of return of 11.6 percent and sells
for $37.80 a share. What is the expected amount of the next dividend?
a. $2.92
B. $3.02
c. $3.13
d. $3.26
e. $3.40

SECTION: 8.1
TYPE: PROBLEMS
8-8
73. The Home Market has adopted a policy of increasing the annual dividend on their
common stock at a constant rate of 3.75 percent annually. The firm is paying an annual
dividend of $1.10 today. What will the dividend be five years from now?
a. $1.16
b. $1.27
C. $1.32
d. $1.37
e. $1.45
D5 = $1.10 (1.0375)5 = $1.32

SECTION: 8.1
TYPE: PROBLEMS
74. A stock pays a constant annual dividend and sells for $28.80 a share. If the market rate of
return on this stock is 7.2 percent, what is the dividend amount?
a. $1.93
b. $2.02
C. $2.07
d. $2.22
e. $2.40

SECTION: 8.1
TOPIC: CONSTANT DIVIDEND
TYPE: PROBLEMS
8-9
75. You have decided you would like to own some shares of the Clean Coal Company but
need a 16 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 this stock if the company pays a
constant $1.75 annual dividend per share?
a. $9.19
B. $10.94
c. $12.69
d. $18.60
e. $22.81

SECTION: 8.1
TOPIC: CONSTANT DIVIDEND
TYPE: PROBLEMS
76. The Herb Garden common stock sells for $43.70 a share and has a market rate of return of
11.6 percent. The company just paid an annual dividend of $1.42 per share. What is the
dividend growth rate?
a. 5.32 percent
b. 5.73 percent
c. 7.82 percent
D. 8.09 percent
e. 8.14 percent

SECTION: 8.1
TOPIC: GROWTH DIVIDEND
TYPE: PROBLEMS
8-10
77. KB Adventures will pay an annual dividend of $3.15 a share on their common stock next
week. Last year, the company paid a dividend of $3.00 a share. The company adheres to a
constant rate of growth dividend policy. What will one share of this common stock be worth
ten years from now if the applicable discount rate is 12.5 percent?
a. $42.00
b. $56.78
c. $65.16
D. $68.41
e. $71.83

SECTION: 8.1
TYPE: PROBLEMS
78. Tom's Health Clinic just paid a $4.40 annual dividend. The company has a policy of
increasing the dividend by 4 percent annually. You would like to purchase 100 shares of stock
in this firm but realize that you will not have the funds to do so for another two years. If you
require a 14 percent rate of return, how much will you be willing to pay for the 100 shares
when you can afford to make this investment?
a. $4,400
B. $4,949
c. $4,576
d. $4,674
e. $4,759

SECTION: 8.1
TYPE: PROBLEMS
8-11
79. Franktown Meats just announced that they are increasing the annual dividend to $1.75 and
establishing a policy whereby the dividend will increase by 2 percent annually thereafter.
How much will one share of this stock be worth six years from now if the required rate of
return is 14.5 percent?
a. $14.00
b. $14.28
c. $14.84
D. $15.77
e. $16.08

SECTION: 8.1
TYPE: PROBLEMS
80. Shares of Do Naught common stock are currently selling for $46.90. The last dividend
paid was $2.21 per share and the market rate of return is 15.8 percent. At what rate is the
dividend growing?
a. 7.69 percent
b. 9.73 percent
C. 10.59 percent
d. 11.09 percent
e. 11.39 percent

SECTION: 8.1
TOPIC: GROWTH RATE
TYPE: PROBLEMS
8-12
81. Cellular Talk is a new firm in a rapidly growing industry. The company is planning on
increasing its annual dividend by 25 percent a year for the next three years and then
decreasing the growth rate to 6 percent per year. The company just paid its annual dividend in
the amount of $0.80 per share. What is the current value of one share of this stock if the
required rate of return is 17 percent?
a. $11.17
B. $12.14
c. $12.94
d. $14.27
e. $15.06

SECTION: 8.1
TOPIC: SUPERNORMAL GROWTH
TYPE: PROBLEMS
82. J&J Exporters paid a $1.80 per share annual dividend last month. The company is
planning on paying $2.00, $2.50, $2.75, and $3.00 a share over the next four years,
respectively. After that the dividend will be constant at $3.20 per share per year. What is the
market price of this stock if the market rate of return is 13 percent?
a. $7.47
b. $15.96
c. $20.73
D. $22.57
e. $24.37

SECTION: 8.1
TYPE: PROBLEMS
8-13
83. Nu-Tek, Inc. is preparing to pay their first dividend. They are going to pay $0.60, $1.20,
and $1.50 a share over the next three years, respectively. After that, the company has stated
that the annual dividend will be $2 per share indefinitely. What is this stock worth to you per
share if you demand a 16 percent rate of return on stocks of this type?
a. $2.37
b. $3.65
c. $5.10
d. $9.42
E. $10.38

SECTION: 8.1
TYPE: PROBLEMS
84. The Slim Waist announced today that they will begin paying annual dividends. The first
dividend will be paid next year in the amount of $.35 a share. The following dividends will be
$.40, $.55, and $.70 a share annually for the following three years, respectively. After that,
dividends are projected to increase by 2.5 percent per year. How much are you willing to pay
to buy one share of this stock if your desired rate of return is 12 percent?
a. $5.47
b. $5.82
c. $5.92
d. $6.03
E. $6.27

SECTION: 8.1
TOPIC: NONCONSTANT DIVIDENDS
TYPE: PROBLEMS
8-14
85. Gloria's Boutique recently paid $1.65 as an annual dividend. Future dividends are
projected at $1.68, $1.72, $1.76, and $1.80 over the next four years, respectively. Beginning
five years from now, the dividend is expected to increase by 2.5 percent annually. What is one
share of this stock worth to you if you require an 11 percent rate of return on similar
investments?
a. $18.49
B. $19.68
c. $21.33
d. $24.33
e. $25.90

SECTION: 8.1
TYPE: PROBLEMS
86. Su Lee's Cookware pays a constant dividend of $0.75 a share. The company announced
today that they will continue to pay this for another 3 years after which time they will
discontinue operations. What is one share of this stock worth today if the required rate of
return is 18 percent?
A. $1.63
b. $2.02
c. $2.59
d. $3.11
e. $4.17

SECTION: 8.1
TYPE: PROBLEMS
8-15
87. Bliley Plumbers pays no dividend at the present time. The company plans to start paying
an annual dividend in the amount of $0.20 a share for three years commencing three years
from today. After that time, the company plans on paying a constant $1 a share dividend
indefinitely. How much are you willing to pay to buy a share of this stock if your required
return is 15 percent?
A. $3.66
b. $3.94
c. $4.37
d. $4.71
e. $4.84

SECTION: 8.1
TYPE: PROBLEMS
88. The Coal Bin is in a downsizing mode. The company paid a $1.40 annual dividend last
year. The company has announced plans to lower the dividend by $.20 a year. Once the
dividend amount becomes zero, the company will cease all dividends and go out of business.
You have a required rate of return of 18 percent on this particular stock given the company's
situation. What is the minimum price you would like to receive if you were to sell your shares
in this firm today?
a. $.70
b. $1.54
C. $2.78
d. $3.87
e. $4.18

SECTION: 8.1
TYPE: PROBLEMS
8-16
89. Simplicity is a relatively new firm that appears to be on the road to great success. The
company paid their first annual dividend yesterday in the amount of $0.15 a share. The
company plans to double each annual dividend payment for the next four years. After that
time, they are planning on paying a constant dividend of $2.50 per share indefinitely. What is
one share of this stock worth today if the market rate of return on similar securities is 13.45
percent?
a. $12.32
b. $12.77
c. $13.77
D. $14.22
e. $14.37

SECTION: 8.1
TYPE: PROBLEMS
90. The Music Hut just paid an annual dividend of $1.05 a share. The projected dividends for
the next five years are $1.07, $1.10, $1.15, $1.20, and $1.25, respectively. After that time, the
dividends will be held constant at $1.40 per share. What is this stock worth today at a 12.5
percent discount rate?
a. $9.59
B. $10.29
c. $11.34
d. $12.67
e. $13.19

SECTION: 8.1
TYPE: PROBLEMS
8-17
91. Home Builders, Inc. is a very cyclical type of business which is reflected in their dividend
policy. The firm pays a $3.50 per share dividend every other year. The last dividend was paid
last year. Four years from now, the company plans to pay a $77 liquidating dividend per
share. What is the current market value of this stock if the market rate of return is 18.5
percent?
a. $41.54
b. $43.32
C. $44.11
d. $46.59
e. $48.37

SECTION: 8.1
TYPE: PROBLEMS
92. Last week, Northern Railways paid an annual dividend of $2.44 per share. The company
has been reducing the dividends by 15 percent each year. How much are you willing to pay to
purchase stock in this company if your required rate of return is 16 percent?
A. $6.69
b. $7.87
c. $36.60
d. $244.00
e. $280.06

SECTION: 8.1
TOPIC: NEGATIVE GROWTH
TYPE: PROBLEMS
8-18
93. Super Sounds is expecting a period of intense growth and has decided to retain more of
their earnings to help finance that growth. As a result, they are going to reduce the annual
dividend by 20 percent a year for the next three years. After that they will maintain a constant
dividend of $1 a share. Last year, the company paid $2.25 as the annual dividend per share.
What is the market value of this stock if the required rate of return is 16 percent?
a. $6.63
B. $7.36
c. $8.08
d. $9.61
e. $11.23

SECTION: 8.1
TYPE: PROBLEMS
94. Shirley's Cool Treats is expecting their ice cream sales to decline due to the increased
interest in healthy eating. Thus, the company has announced that they will be reducing their
annual dividend by 4 percent a year for the next four years. After that, they will maintain a
constant dividend of $1 a share. Last year, the company paid $1.80 per share. What is this
stock worth to you if you require a 12 percent rate of return?
a. $9.29
B. $10.27
c. $11.30
d. $12.07
e. $13.10

SECTION: 8.1
TYPE: PROBLEMS
8-19
95. Wenton & Straus wants to issue preferred stock that pays an annual dividend of $6 a
share. The company has determined that stocks with similar characteristics provide a 14.8
percent rate of return. What should the offer price be?
a. $35.23
b. $36.00
C. $40.54
d. $46.54
e. $88.80
P = $6.00 / .148 = $40.54

SECTION: 8.1
TOPIC: PREFERRED STOCK
TYPE: PROBLEMS
96. The preferred stock of West Coast Limited pays an annual dividend of $5.50 and sells for
$52 a share. What is the rate of return on this security?
a. 9.45 percent
b. 9.83 percent
c. 10.48 percent
D. 10.58 percent
e. 10.77 percent
R = $5.50 / $52.00 = 10.58 percent

SECTION: 8.1
TYPE: PROBLEMS
8-20
97. Stu owns shares of Markley preferred stock which he says provides him with a constant
13.6 percent rate of return. The stock is currently priced at $51.47 a share. What is the amount
of the dividend per share?
a. $2.64
b. $3.78
c. $5.85
d. $6.26
E. $7.00
D = .136 $51.47 = $7.00

SECTION: 8.1
TYPE: PROBLEMS
98. Wilmington Importers preferred stock pays a $5 annual dividend. What is the maximum
price you are willing to pay for one share of this stock if your required return is 15.5 percent?
A. $32.26
b. $35.48
c. $72.68
d. $77.50
e. $79.81
P0 = $5.00 / .155 = $32.26

SECTION: 8.1
TYPE: PROBLEMS
8-21
Essay Questions
99. What are the primary differences between NASDAQ and the NYSE?
The NYSE has a physical trading floor in New York City, is a dealer market, relies on
specialists and brokers, and utilizes the SuperDOT system. NASDAQ is an electronic network
of dealers and utilizes a multiple market maker system. NASDAQ has no physical trading
floor.
AACSB TOPIC: REFLECTIVE THINKING

SECTION: 8.3
TOPIC: NASDAQ VS. NYSE
100. What are the components of the total rate of return on a share of stock? Briefly explain
each component.
The two components are the dividend yield and the capital gains yield. The dividend yield is
the percentage of the current stock price which is expected to be distributed next year as a
dividend. The dividend yield is expressed as Dt+1 / Pt. The capital gains yield is the change in
the stock price expressed as a percentage of the current stock value. The capital gains yield is
expressed as (Pt+1 Pt) / Pt.

SECTION: 8.1
101. Briefly explain the differences between preferred and common stock.
Common stockholders have the right to vote on corporate matters and have the right to
receive the residual value of the firm after all liabilities and preferred stockholders are paid in
a liquidation. Preferred stockholders have a promised dividend, may or may not have the right
to collect dividends that have been passed, and typically will be rated much like bonds. In a
liquidation, preferred shareholders have a preference over common stockholders.

SECTION: 8.2
TOPIC: PREFERRED VS. COMMON STOCK
8-22
102. Explain whether it is easier to find the required return on a publicly traded stock or a
publicly traded bond, and explain why.
Bonds, unlike stocks, have a final maturity date and promised payments at fixed periods of
time. Thus, once an appropriate discount rate is established, valuing a bond is relatively
simple. For stocks, the only valuation model we have up to this point in the text is the
dividend growth model which requires estimation of a dividend growth rate and also requires
that the growth rate be less than the required return. Normally, all of the information required
to find the yield on a publicly traded bond is publicly available while only the price and the
most current dividend are available for stocks.

SECTION: 8.1
TOPIC: STOCKS VS. BONDS
103. A number of publicly traded firms pay no dividends yet investors are willing to buy
shares in these firms. How is this possible? Does this violate our basic principle of stock
valuation? Explain.
The basic principle of stock valuation computes the value of a share of stock as the present
value of all the expected dividends on the stock. According to the dividend growth model, an
asset that has no expected cash flows has a value of zero. If investors are willing to purchase
shares of stock in firms that pay no dividends, they must expect the firms will begin paying
dividends at some point in the future.

SECTION: 8.1
TOPIC: ZERO-DIVIDEND STOCKS
104. Explain the primary change that occurred in the structure of the NYSE in 2006 and how
that change affected the exchange members.
In 2006, the NYSE become a publicly owned corporation called NYSE Group, Inc. Exchange
members no longer purchase, or own, seats on the exchange. Members now purchase trading
licenses which grant their owners the right to transact trades on the floor of the exchange.

SECTION: 8.2
TOPIC: NYSE
8-23

Chapter 008 Stock Valuation: Aacsb Topic: Analytic SECTION: 8.1 Topic: Stock Value Type: Problems

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Chapter 008 Stock Valuation: Aacsb Topic: Analytic SECTION: 8.1 Topic: Stock Value Type: Problems

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Chapter 008 Stock Valuation

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

Dividend yield = .138 .042 = 9.6 percent

AACSB TOPIC: ANALYTIC

g = .246 .006 = .24 = 24.0 percent

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

D5 = $1.10 (1.0375)5 = $1.32

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

AACSB TOPIC: ANALYTIC

P = $6.00 / .148 = $40.54

AACSB TOPIC: ANALYTIC

R = $5.50 / $52.00 = 10.58 percent

AACSB TOPIC: ANALYTIC

D = .136 $51.47 = $7.00

AACSB TOPIC: ANALYTIC

P0 = $5.00 / .155 = $32.26

AACSB TOPIC: ANALYTIC

AACSB TOPIC: REFLECTIVE THINKING

AACSB TOPIC: REFLECTIVE THINKING

AACSB TOPIC: REFLECTIVE THINKING

AACSB TOPIC: REFLECTIVE THINKING

AACSB TOPIC: REFLECTIVE THINKING

AACSB TOPIC: REFLECTIVE THINKING

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