Chapter 05

The Value of Common Stocks

Multiple Choice Questions:

1. CK Company stockholders expect to receive a year-end dividend of $5 per

share and then be sold for $115 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

P = (115+5)/1.2 = 100
 

2. 16. (p.  100) Deluxe Company expects to pay a dividend of $2 per share at the end
of year-1, $3 per share at the end of year -2 and then be sold for $32 per share.
If the required rate on the stock is 15%, what is the current value of the stock? 
A. $28.20
b. $32.17
c. $32.00
d. None of the given answers

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

 

3. Casino Inc. is expected to pay a dividend of $3 per share at the end of year-1
(D1) and these dividends are expected to grow at a constant rate of 6% per year
forever. If the required rate of return on the stock is 18%, what is current value
of the stock today? 
A. $25
b. $50
c. $100
d. $54

P0 = Div1/ (r-g) = (3/(0.18-0.06)) = 25

4. Will Co. is expected to pay a dividend of $2 per share at the end of year -1(D1)
and the dividends are expected to grow at a constant rate of 4% forever. If the
current price of the stock is $20 per share calculate the expected return or the
cost of equity capital for the firm: 
a. 10%
b. 4%
C. 14%
d. None of the above
r = [(D1/P0) + g] = (2/20) + 0.04 = 14%
 5. General Electric (GE) has about 10.3 billion shares outstanding and the stock
price is $37.10. The P/E ratio is about 18.3. Calculate the market capitalization
for GE. (Approximately) 
a. $679 billion
b. $188 billion
C. $382 billion
d. None of the above

Market capitalization = (10.3)(37.10) = $382.13 billion

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

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

Constant growth valuation: Answer: c

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

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

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

Constant growth valuation Answer: e

D0 $1.75
rs 12.0%
g 4.0%
D1 = D0(1 + g) = $1.82 Intermediate step used to find answer
P0 = D1/(rs – g) $22.75
 8. A share of common stock has just paid a dividend of $2.00. If the expected
long-run growth rate for this stock is 5.0%, and if investors' required rate of
return is 10.5%, what is the stock price?

A. $35.39
B. $36.30
C. $37.23
D. $38.18
E. $39.14

Constant growth valuation Answer: d

Last dividend (D0) $2.00

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

9. Ewert Enterprises' stock currently sells for $30.50 per share. The stock’s dividend is
projected to increase at a constant rate of 4.50% per year. The required rate of return on
the stock, rs, is 10.00%. What is Ewert's expected price 3 years from today?

a. $31.61
b. $32.43
c. $33.26
d. $34.11
e. $34.81

Future price of a constant growth stock: Answer: e EASY

Stock price $30.50

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

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

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

Future price of a constant growth stock Answer: e EASY

Growth rate 3.75%

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

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

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

Constant growth valuation: CAPM Answer: a

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

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

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

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

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

A. $0.95
B. $1.05
C. $1.16
D. $1.27
E. $1.40
Constant growth dividend Answer: b

Stock price $25.00

Required return 11.50%
Growth rate 7.00%
P0 = D1/(rs – g), so D1 = P0(rs – g) =$1.13 Intermediate step
Last dividend = D1/(1 + g) $1.05