Chapter 04 Test Bank - Static

1.
The major secondary market for GE shares is the
A. London Stock Exchange.

B. New York Stock Exchange.
C. Nasdaq.
D. Tokyo Stock Exchange.
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Difficulty: Intermediate
2. Assume General Electric (GE) has about 10.3 billion shares outstanding and the stock price is $37.10.
Also, assume the P/E ratio is about 18.3. Calculate the approximate market capitalization for GE.
A. $679 billion
B. $188 billion
C. $382 billion
D. $103 billion

3. The following are foreign companies that are traded on the New York Stock Exchange:
A. Sony, Telefonica Brasil, and Canadian Pacific only.

B. Sony, Telefonica Brasil, Canadian Pacific, and Tata Motors only.
C. Sony, Telefonica Brasil, Canadian Pacific, and General Electric only.
D. all of the given companies.

4. The dividend yield reported on finance.yahoo.com is calculated as follows:
A. (dividend/year-high stock price).

B. (dividend/year-low stock price).
C. (dividend/closing stock price).
D. (dividends/earnings).

5. A Wall Street Journal quotation for a company has the following values: Div: $1.12, PE: 18.3, Close:
$37.22. Calculate the approximate dividend payout ratio for the company.
A. 18 percent
B. 35 percent
C. 45 percent
D. 55 percent

Difficulty: Challenge
6. If a Wall Street Journal quotation for a company has the values Close = 55.14 and Net change = +1.04, then
what was the closing price for the stock for the previous trading day?
A. $56.18
B. $54.10
C. $55.66
D. $53.02
7. The following are auction markets except the
A. New York Stock Exchange.

B. London Stock Exchange.
C. Tokyo Stock Exchange.
D. Nasdaq.

Difficulty: Basic
8. The following is an example of a dealer market:
A. New York Stock Exchange

B. London Stock Exchange
C. Tokyo Stock Exchange
D. Nasdaq
Difficulty: Basic
9. In which of the following stock exchanges are there designated market makers who act as auctioneers?
A. New York Stock Exchange

B. London Stock Exchange
C. Tokyo Stock Exchange
D. Deutsche Borse

10. In which of the following exchanges does a computer act as the sole auctioneer?
A. New York Stock Exchange, London Stock Exchange, Tokyo Stock Exchange, and Deutsche Borse
B. New York Stock Exchange, Tokyo Stock Exchange, and Deutsche Borse only
C. New York Stock Exchange, London Stock Exchange, and Tokyo Stock Exchange only
D. London Stock Exchange, Tokyo Stock Exchange, and Deutsche Borse only

11. Super Computer Company's stock is selling for $100 per share today. It is expected that, at the end of one
year, it will pay a dividend of $6 per share and then be sold for $114 per share. Calculate the expected rate of
return for the shareholders.
A. 20 percent
B. 15 percent
C. 10 percent
D. 25 percent

12. The valuation of a common stock today primarily depends on
A. the number of shares outstanding and the number of its shareholders.

B. its expected future dividends and its discount rate.
C. Wall Street analysts.
D. the price to earnings ratio.

Difficulty: Basic
13. CK Company stockholders expect to receive a year-end dividend of $5 per share and then immediately sell
their shares for $115 dollars per share. If the required rate of return for the stock is 20 percent, what is the current
value of the stock?
A. $132
B. $122
C. $100
D. $110

14. 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 at the end of year 2. If the required rate of return on the stock is 15
percent, what is the current value of the stock?
A. $28.20
B. $32.17
C. $32.00
D. $29.18

15. Casino Inc. expects to pay a dividend of $3 per share at the end of year 1 (Div1) and these dividends are
expected to grow at a constant rate of 6 percent per year forever. If the required rate of return on the stock is 18
percent, what is the current value of the stock today?
A. $25
B. $50
C. $100
D. $54

16. The constant dividend growth formula P0 = Div1/(r - g) assumes .
A. that dividends grow at a constant rate g, forever only.

B. r > g only.
C. that dividends grow at a constant rate g, forever, and r > g only.
D. g is never negative only.

17. Will Co. is expected to pay a dividend of $2 per share at the end of year 1(Div1), and the dividends are
expected to grow at a constant rate of 4 percent 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 percent
B. 4 percent
C. 14 percent
D. 20 percent

18. World-Tour Co. has just now paid a dividend of $2.83 per share (Div0); its dividends are expected to grow
at a constant rate of 6 percent per year forever. If the required rate of return on the stock is 16 percent, what is
the current value of the stock, after paying the dividend?
A. $70
B. $56
C. $30
D. $48

19. One can estimate the expected rate of return or the cost of equity capital as
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).
20. One can estimate the dividend growth rate for a stable firm 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).

21. MJ Co. pays out 60 percent of its earnings as dividends. Its return on equity is 15 percent. What is the
stable dividend growth rate for the firm?
A. 9 percent
B. 5 percent
C. 6 percent
D. 15 percent

22. Michigan Co. just paid a dividend of $2 per share. Analysts expect future dividends to grow at 20 percent per
year for the next four years and then grow at 6 percent per year thereafter. Calculate the expected dividend in year
5.
A. $4.15
B. $2.95
C. $4.40
D. $3.81

23. Otobai Motor Company just paid a dividend of $1.40. Analysts expect its dividend to grow at a rate of 18
percent for the next three years and then a constant rate of 5 percent thereafter. What is the expected dividend
per share at the end of year 5?
A. $2.35
B. $2.54
C. $2.91
D. $1.50

24. The In-Tech Co. just paid a dividend of $1 per share. Analysts expect its dividend to grow at 25 percent per
year for the next three years and then 5 percent per year thereafter. If the required rate of return on the stock is
18 percent, what is the current value of the stock?
A. $12.97
B. $11.93
C. $15.20
D. $15.78

25. R&D Technology Corporation just paid a dividend of $0.50 per share. Analysts expect its dividend to grow at
24 percent per year for the next two years and then 8 percent per year thereafter. If the required rate of return in
the stock is 16 percent, calculate the current value of the stock.
A. $1.11
B. $7.71
C. $8.82
D. $10.38

26. Ocean Co. just paid a dividend of $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 percent
B. 12 percent
C. 8 percent
D. 4 percent

27. Seven-Seas Co. just paid a dividend of $3 per share out of earnings of $5 per share. If its book value per share
is $40.00 and its market price is $52.50 per share, calculate the required rate of return on the stock.
A. 12 percent
B. 11 percent
C. 5 percent
D. 6 percent

28. River Co. just paid a dividend of $2 per share out of earnings of $4 per share. If its book value per share is
$25 and its stock is currently selling for $40 per share, calculate the required rate of return on the stock.
A. 15.2 percent
B. 7.2 percent
C. 14.7 percent
D. 13.4 percent

29. Lake Co. just paid a dividend of $3 per share out of earnings of $5 per share. If its book value per share is
$40, what is the expected growth rate in dividends?
A. 7.5 percent
B. 8 percent
C. 12.5 percent
D. 5 percent

30. The growth rate in dividends is a function of two ratios. They are
A. ROA and ROE.

B. dividend yield and growth rate in stock price.
C. ROE and the plowback ratio.
D. book value per share and EPS.

31. 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. $6 per share
B. $10 per share
C. $0.20 per share
D. $5 per share

32. Which of the following formulas regarding the earnings-to-price ratio is true?
A. EPS/P0 = r[1 + PVGO/P0]

B. EPS/P0 = r[1 - PVGO/P0]
C. EPS/P0 = [r + PVGO/P0]
D. EPS/P0 = [1 + r + PVGO/P0)]/r

33. Generally, high growth stocks pay
A. low or no dividends.
B. high, steadily growing dividends.
C. erratic dividends.
D. decreasing dividends.

34. A high proportion of the value of a growth stock typically comes from
A. past dividend payments.

B. past earnings.
C. PVGO (present value of growth opportunities).
D. past dividend payments and past earnings.
35. Summer Co. expects to pay a dividend of $4.00 per share—one year from now—out of earnings of $7.50 per
share. If the required rate of return on the stock is 15 percent and its dividends are growing at a constant rate of
10 percent per year, calculate the present value of growth opportunities for the stock (PVGO).
A. $80
B. $30
C. $50
D. $26

36. Parcel Corporation expects to pay a dividend of $5 per share next year, and the dividend payout ratio is 50
percent. If dividends are expected to grow at a constant rate of 8 percent forever, and the required rate of return
on the stock is 13 percent, calculate the present value of growth opportunities.
A. $100.00
B. $76.92
C. $23.08
D. $69.54

37. Which of the following stocks is a growth stock?
A. Dow Chemical
B. Consolidated Edison
C. General Electric
D. Google

Difficulty: Basic
38. Universal Air is a no-growth firm and has two million shares outstanding. It expects to earn a constant $20
million per year on its assets. If it has no debt, all earnings are paid out as dividends, and the cost of capital is 10
percent, calculate the current price per share of the stock.
A. $200
B. $150
C. $100
D. $50

39. Analysts often value companies by forecasting a series of cash flows and then estimating a horizon value.
Suppose a firm forecasts a project's net cash flows ($millions) in years 1 through 4 as $120, $130, $135, and
$137, respectively. If the project ends at the end of the fourth year, what is the horizon value of the project?
Assume that the company had a historical growth rate of 3 percent and has a discount rate of 10 percent.
A. $0.00
B. $1.37
C. $1.96
D. $4.87
40. A company forecasts growth of 6 percent for the next five years and 3 percent thereafter. Given last year's
free cash flow was $100, what is its horizon value (PV looking forward from year 4) if the company cost of capital
is 8 percent?
A. $0
B. $1,672
C. $2,000
D. $2,676

41. Galaxy Air, previously a no-growth firm, has two million shares outstanding. Until now, it consistently earned
$20 million per year on its assets. (It has no debt and pays out all earnings as dividends. Its cost of capital is 10
percent.) Due to its newly appointed CEO, Galaxy Air is now able to squeeze out 1 percent annual growth by
plowing back 5 percent of earnings. Calculate its stock price per share.
A. $200.00
B. $106.61
C. $100.00
D. $110.10

42. Ottocell Motor Company just paid a dividend of $1.40. Analysts expect its dividend to grow at a rate of 10
percent next year, 8 percent for the following two years, and then a constant rate of 5 percent thereafter. What is
the expected dividend per share at the end of year 5?
A. $2.08
B. $1.98
C. $1.80
D. $0.99

43. Most exchange traded funds are not actively managed.
TRUE

Difficulty: Basic
44. The New York Stock Exchange is the only stock market in the United States.
FALSE

Difficulty: Basic
45. Most of the trading on the NYSE is in ordinary common stocks.
TRUE

Difficulty: Basic
46. The return that is expected by investors from a common stock is also called its market capitalization rate, or
cost of equity capital.
TRUE

47. All securities in an equivalent risk class are priced to offer the same expected return.
TRUE

48. The only payoff to the owners of common stocks is in the form of cash dividends.
FALSE

49. The constant growth formula for stock valuation does not work for a firm with a negative growth rate
(i.e., a declining growth rate) in its dividend.
FALSE

50. The cost of equity capital equals the dividend yield minus the growth rate in dividends for a constant
dividend growth stock.
FALSE

51. It is not possible to value a firm that has a supernormal (variable) growth rate for the first few years of its life.
FALSE

52. A large percentage of the total value of a growth stock comes from the present value of its growth opportunities.
TRUE

53. One can use the discounted cash flow formulas that are used to value common stocks in order to value
entire businesses.
TRUE

Difficulty: Basic
54. An investor who uses a limit order instructs his brokerage firm to buy a limited quantity of shares at the
best available price.
FALSE

55. An investor who uses a market order instructs her brokerage firm to buy a given quantity of shares at the
best available price.
TRUE

56. For most firms, market value is usually greater than book value.
TRUE

Difficulty: Basic
57. A stock's price is based on the expected present value, at the market capitalization rate, of all the stock's
future earnings.
FALSE

58. Explain the term primary market.
When new shares of common stocks are first sold to investors—usually in an IPO (initial public offering)
—in order to raise capital, it is called a primary market transaction.
Difficulty: Easy
59. Explain the term secondary market.
When already issued stocks are traded in the market, it is called a secondary market transaction. Most
transactions in the stock market (e.g., trades on the NYSE) are secondary market transactions.
Difficulty: Easy
60. Briefly explain the major types of exchanges prevalent in the United States.
There are two types of exchanges prevalent in the United States. They are auction markets and dealer
markets. The New York Stock Exchange is an example of an auction market. Here designated market
makers can act as auctioneers and match up would-be buyers and sellers. However, even on the
NYSE, most trades are made electronically. The Nasdaq is an example of a dealer market. In the case
of a dealer market, all trades take place between a group of dealers and investors. Dealer markets are
also active in trading many other types of financial instruments such as bonds.
Difficulty: Medium
61. Briefly explain the term market capitalization rate.
The rate of return expected by the investors in common stocks is called the market capitalization rate. Market
capitalization rate is also called the cost of equity capital. For a constant growth stock, it equals the dividend
yield plus the expected growth rate in dividends.
Difficulty: Medium
62. Discuss the general principle at work in valuing a common stock.
The value of a common stock is the expected present value of all the dividends received by owning the stock,
discounted at the market capitalization rate, or the cost of equity. This is the discounted cash flow (DCF)
method.
Difficulty: Medium
63. Briefly explain the assumptions associated with the constant dividend growth formula.
There are two important assumptions that are necessary for the formula to work correctly. The first assumption
is that the expected growth rate of dividends is constant. The second assumption is that the discount rate is
greater than the expected growth rate in dividends.
Difficulty: Difficult
64. Discuss the term price-earnings (P/E) ratio.
The P/E ratio is a widely used financial indicator, but is also quite ambiguous. Generally, a high P/E ratio indicates
that the investors think a firm has good growth potential. It is the ratio of current market price and earnings of a
stock. However, a high P/E ratio can result from very low earnings.
Difficulty: Medium
65. Briefly explain how the formulas that are used for valuing common stocks can also be used to value
businesses.
The formulas that are used to value common stocks can also be used to value entire businesses. In the case of
businesses, free cash flows generated by the businesses are discounted. Typically, a two-stage DCF model is
used. Free cash flows are forecasted out to a horizon and discounted to present value. Then a horizon value is
forecasted, discounted, and added to the present value of free cash flows. The sum is the value of the business.
This may look easy in theory but is quite complicated in practice.
66. Briefly explain why Microsoft experienced a significant drop in price when it announced its first-ever
regular dividend along with huge profits.
Under the concept of PVGO, Microsoft was converting from a company with significant growth to a company with
no growth. An increase in the dividend for a growth company is often a sign of reduced growth. Thus, the market
would have reacted negatively to the news.
Category # of
Questions
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Difficulty: Basic 9
Difficulty: Challenge 1
Difficulty: Difficult 3
Difficulty: Easy 2
Difficulty: Intermediate 47
Difficulty: Medium 4

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1.

The major secondary market for GE shares is the

A. London Stock Exchange.

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Accessibility: Keyboard Navigation

A. Sony, Telefonica Brasil, and Canadian Pacific only.

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4. The dividend yield reported on finance.yahoo.com is calculated as follows:

A. (dividend/year-high stock price).

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A. New York Stock Exchange.

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8. The following is an example of a dealer market:

A. New York Stock Exchange

A. New York Stock Exchange

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Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

12. The valuation of a common stock today primarily depends on

A. the number of shares outstanding and the number of its shareholders.

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

A. that dividends grow at a constant rate g, forever only.

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Accessibility: Keyboard Navigation

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A. Dividend yield - expected rate of growth in dividends.

A. plow-back rate/the return on equity (ROE).

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A. ROA and ROE.

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A. EPS/P0 = r[1 + PVGO/P0]

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33. Generally, high growth stocks pay

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A. past dividend payments.

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37. Which of the following stocks is a growth stock?

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43. Most exchange traded funds are not actively managed.

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45. Most of the trading on the NYSE is in ordinary common stocks.

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