Fundamentals of Corporate Finance 3rd Edition Berk Test Bank

Fundamentals of Corporate Finance 3rd Edition Berk Test Bank
Fundamentals of Corporate Finance 3rd Edition Berk

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Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 7 Stock Valuation
7.1 Stock Basics
1) The ownership in a corporation is divided into shares of stock, which carry rights to a share in the
profits of the firm through future dividend payments.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
2) What are dividend payments?

A) payments made to a company by investors for a share of the ownership of that company
B) incremental increases in the value of the stock held by an investor due to rises in share price
C) the difference between the original cost price of a share and the price an investor receives when that
share is sold
D) a share of the profits paid to each shareholder on the basis of the number of shares they hold
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
1
Copyright © 2015 Pearson Education, Inc.
3)
The above screen shot from Google Finance shows basic stock information for PepsiCo. If you owned
of PepsiCo for the period shown, how much would you have earned in dividend payments?
A) $480.00
B) $658.44
C) $584.80
D) $688.00
Answer: D
Explanation: D) 1600 × $0.43 = $688.00
Diff: 1 Var: 21
Skill: Analytical
Author: DS
2
Use the figure for the question(s) below.
4) The above screen shot from Google Finance shows the basic stock information for Logitech
International SA (USA). What is Logitech International SA (USA)'s ticker symbol?
A) LIS
B) LOGITECH
C) LOG
D) LOGI
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
Question Status: Previous Edition
3
5) The above screen shot from Google Finance shows the basic stock information for Logitech
International SA (USA) after the close of business on August 22, 2008. What is the difference between the
opening and closing price of the stock on this date?
A) $0.49
B) $0.27
C) $0.24
D) $0.03
Answer: C
Explanation: C) $26.30 - $26.06 = $0.24
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4
6) The above screen shot from Google Finance shows the basic stock information for Kraft Foods Inc. after
the close of the stock market on May 30, 2008. What is the highest that the stock has traded at in the last
12 months?
A) $32.44
B) $32.48
C) $32.99
D) $35.29
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
5
7) The above screen shot above from Google Finance shows the price history of Progenics, a
pharmaceutical company. In the time period shown, Progenics released information that an
intravenously-administered formulation of their leading product had failed in a Phase III clinical trial. In
which of the months shown in the price history is this most likely to have occurred?
A) February 2008
B) March 2008
C) April 2008
D) May 2008
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
8) What role do dividends play in stock investing?

Answer: Dividends are periodic payments given out by the firm to shareholders. It is not necessary for a
firm to declare dividends, but mature firms tend to pay out dividends.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
6
7.2 The Mechanics of Stock Trades
1) A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
2) You placed an order to purchase stock where you specified the maximum price you were willing to
pay. This type of order is known as a ________.
A) maximum order
B) limit order
C) floor order
D) market order
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
3) A "round lot" consists of how many shares?

A) 1
B) 10
C) 100
D) 1,000
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
7.3 The Dividend-Discount Model
1) The Valuation Principle states that the value of a stock is equal to the present value (PV) of both the
dividends and future sale price of that stock which the investor will receive.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
7
2) Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If
Owen's equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it
pays the dividend?
A) $11.20
B) $12.80
C) $16.80
D) $16.00
Answer: D
Explanation: D) (1 + 0.12) × $15.00 = $16.80;
$16.80 - $0.80 = $16.00
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
3) Which of the following will be a source of cash flows for a shareholder of a certain stock?
I. Sale of the shares at a future date
II. The firm in which the shares are held paying out cash to shareholders in the form of dividends
III. The firm in which the shares are held increasing the total number of shares outstanding through a
stock split
A) I only
B) II only
C) I and II
D) II and III
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
4) Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If
the current price of Coolibah stock is $22.60, and Coolibah's equity cost of capital is 18%, what price
would you expect Coolibah's stock to sell for at the end of three years?
A) $28.87
B) $31.76
C) $33.20
D) $34.64
Answer: A
Explanation: A) Using a financial calculator, ,
calculate
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
8
5) Matilda Industries pays a dividend of $2.10 per share and is expected to pay this amount indefinitely.
If Matilda's equity cost of capital is 9%, which of the following would be closest to Matilda's stock price?
A) $14.00
B) $18.66
C) $23.33
D) $29.16
Answer: C
Explanation: C) PV0 = $2.10 / 0.09 = $23.33
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
6) Jumbuck Exploration has a current stock price of $3.00 and is expected to sell for $3.15 in one year's
time, immediately after it pays a dividend of $0.28. Which of the following is closest to Jumbuck
Exploration's equity cost of capital?
A) 7.17%
B) 8.60%
C) 14.33%
D) 17.91%
Answer: C
Explanation: C)
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
7) A stock is bought for $23.00 and sold for $27.00 one year later, immediately after it has paid a dividend
of $1.50. What is the capital gain rate for this transaction?
A) 3.48%
B) 8.70%
C) 13.91%
D) 17.39%
Answer: D
Explanation: D)
Diff: 1 Var: 35
Skill: Analytical
Author: DS
9
8) Credenza Industries is expected to pay a dividend of $1.70 at the end of the coming year. It is expected
to sell for $62 at the end of the year. If its equity cost of capital is 9%, what is the expected capital gain
from the sale of this stock at the end of the coming year?
A) $3.56
B) $56.88
C) $5.12
D) $58.44
Answer: A
Explanation: A) P0 using the capital gain rate formula = ($1.70 + $62) / (1 + 0.09) = $58.44;
Capital gain = P1 - P0 = $62 - $58.44 = $3.56
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
9) The Busby Corporation had a share price at the start of the year of $26.10, paid a dividend of $0.59 at
the end of the year, and had a share price of $29.50 at the end of the year. Which of the following is closest
to the rate of return of investments in companies with equal risk to The Busby Corporation for this
period?
A) 14%
B) 13%
C) 12%
D) 15%
Answer: D
Explanation: D) $29.50 + $0.59 - $26.10 = $3.99;
$3.99 / $26.10 = 15.29%; rounded to 15%
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
10
10) Valorous Corporation will pay a dividend of $1.75 per share at this year's end and a dividend of $2.35
per share at the end of next year. It is expected that the price of Valorous' stock will be $41 per share after
two years. If Valorous has an equity cost of capital of 9%, what is the maximum price that a prudent
investor would be willing to pay for a share of Valorous stock today?
A) $32.38
B) $36.19
C) $38.09
D) $39.99
Answer: C
Explanation: C) Using a financial calculator,
calculate NPV at equals $38.09.
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
11) A stock is expected to pay $0.70 per share every year indefinitely. If the current price of the stock is
$18.90, and the equity cost of capital for the company that released the shares is 7.9%, what price would
an investor be expected to pay per share five years into the future?
A) $8.86
B) $14.18
C) $14.62
D) $15.06
Answer: A
Explanation: A) P0 = $0.70 / 0.079 = $8.86
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
12) A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the
company is 8.4%. What price would an investor be expected to pay per share ten years in the future?
A) $14.88
B) $22.32
C) $29.76
D) $37.20
Answer: A
Explanation: A) P0 = $1.25 / 0.084 = $14.88
Diff: 1 Var: 50+
Skill: Analytical
Author: WC
11
13) Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price
of Rylan stock is $31.27, and Rylan's equity cost of capital is 12%, what price would you expect Rylan's
stock to sell for at the end of the four years?
A) $21.96
B) $39.53
C) $17.57
D) $61.49
Answer: A
Explanation: A) Using a financial calculator,
Calculate
Diff: 1 Var: 50+
Skill: Analytical
Author: WC
14) A stock is expected to pay $2.60 per share every year indefinitely and the equity cost of capital for the
company is 11%. What price would an investor be expected to pay per share next year?
A) $5.91
B) $11.82
C) $17.73
D) $23.64
Answer: D
Explanation: D) P0 = $2.60 / 0.11 = $23.64
Diff: 1 Var: 50+
Skill: Analytical
Author: WC
Question Status: New
7.4 Estimating Dividends in the Dividend-Discount Model
1) A firm can either pay its earnings to its investors, or it can keep them and reinvest them.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
12
2) Which of the following is NOT a way that a firm can increase its dividend?
A) by increasing its retention rate
B) by decreasing its shares outstanding
C) by increasing its earnings (net income)
D) by increasing its dividend payout rate
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
3) Which of the following statements is FALSE regarding profitable and unprofitable growth?
A) If a firm wants to increase its share price, it must diversify.
B) If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends.
C) A firm can increase its growth rate by retaining more of its earnings.
D) Cutting a firm's dividend to increase investment will raise the stock price if the new investment has a
positive net present value (NPV).
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
4) Which of the following statements is FALSE?

A) Estimating dividends, especially for the distant future, is difficult.
B) A firm can only pay out its earnings to investors or reinvest their earnings.
C) Successful young firms often have high initial earnings growth rates.
D) According to the constant dividend growth model, the value of the firm depends on the current
dividend level, divided by the equity cost of capital plus the grow rate.
Answer: D
Explanation: D) According to the constant dividend growth model, the value of the firm depends on the
current dividend level, divided by the equity cost of capital adjusted by the growth rate.
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
13
5) Which of the following statements is FALSE of the dividend-discount model?
A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing
growth.
B) As firms mature, their growth slows to rates more typical of established companies.
C) The dividend-discount model values the stock based on a forecast of the future dividends paid to
shareholders.
D) The simplest forecast for the firm's future dividends states that they will grow at a constant rate, i.e.,
forever.
Answer: A
Explanation: A) A multistage dividend-discount model can be used to value the stock of a firm with
rapid or changing growth.
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
6) Which of the following statements is FALSE about dividend payout and growth?
A) A common approximation is to assume that in the long run, dividends will grow at a constant rate.
B) The dividend each year is the firm's earnings per share (EPS) multiplied by its dividend payout rate.
C) There is a tremendous amount of uncertainty associated with any forecast of a firm's future dividends.
D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to
shareholders in the form of dividends.
Answer: D
Explanation: D) During periods of high growth, it is not unusual for these firms to retain 100% of their
earnings to exploit profitable investment opportunities.
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
7) Which of the following statements is FALSE?

A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends.
B) Total return equals earnings multiplied by the dividend payout rate.
C) Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new
investments have a positive net present value (NPV).
D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing
growth.
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
14
8) Which of the following formulas is INCORRECT?
A) g = Retention Rate × Return on New Investment
B) Divt = EPSt × Dividend Payout Rate
C) P0 = Div1 / (rE - g)
D) rE = (Div1 / P0) - g
Answer: D
Explanation: D) rE = (Div1 / P0) + g
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
9) Which of the following formulas is INCORRECT?

A) Divt = EPSt × Dividend Payout Rate
B) PN = (rE - g) × DivN+1
C) earnings growth rate = retention rate × return on new investment
D) rE = (Divt / P0) + g
Answer: B
Explanation: B) PN =
Diff: 1 Var: 1
Skill: Conceptual
Author: JN
10) NoGrowth Industries presently pays an annual dividend of $1.20 per share and it is expected that
these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 10%, then the
value of a share of NoGrowth's stock is closest to ________.
A) $9.60
B) $14.40
C) $13.20
D) $12.00
Answer: D
Explanation: D)
Diff: 1 Var: 50+
Skill: Analytical
Author: JN
15
11) Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect
VBC's dividend to grow by 6% per year forever and VBC's equity cost of capital to be 13%, then the value
of a share of VBS stock is closest to ________.
A) $42.86
B) $15.79
C) $25.72
D) $17.14
Answer: A
Explanation: A)
Diff: 1 Var: 50+
Skill: Analytical
Author: JN
12) Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industries'
dividends are expected to grow at a constant rate indefinitely. The growth rate of Luther's dividends is
closest to ________.
A) 5.5%
B) 14.5%
C) 11.0%
D) 5.0%
Answer: A
Explanation: A) rE = Div1 / P0 + g
0.1 = 0.045 + g, so g = 5.5%
Diff: 1 Var: 50+
Skill: Analytical
Author: JN
13) The Sisyphean Company's common stock is currently trading for $25.50 per share. The stock is
expected to pay a $2.80 dividend at the end of the year and the Sisyphean Company's equity cost of
capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate
in the Sisyphean Company's earnings is closest to ________.
A) -1.96%
B) -1.47%
C) -0.98%
D) -0.49%
Answer: C
Explanation: C)
Diff: 1 Var: 50+
Skill: Analytical
Author: JN
16
14) You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will
pay out $1.25 of these earnings to shareholders in the form of a dividend. KTI's return on new
investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTI's dividends is
A) 11.3%
B) 9.8%
C) 5.9%
D) 3.9%
Answer: B
Explanation: B) g = Retention rate × Return on new investment
= ($5 - $1.25) / $5 × 0.13 = 0.0975 or 9.8%
Diff: 1 Var: 50+
Skill: Analytical
Author: JN
15) You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will
pay out $2.50 of these earnings to shareholders in the form of a dividend. KTI's return on new
investments is 14% and their equity cost of capital is 11%. The value of a share of KTI's stock today is
A) $75.00
B) $37.50
C) $62.50
D) $25.00
Answer: C
Explanation: C) g = Retention rate × Return on new investment
Diff: 2 Var: 50+

Skill: Analytical
Author: JN
17
16) JRN Enterprises just announced that it plans to cut its dividend from $3.00 to $1.50 per share and use
the extra funds to expand its operations. Prior to this announcement, JRN's dividends were expected to
grow indefinitely at 4% per year and JRN's stock was trading at $25.50 per share. With the new
expansion, JRN's dividends are expected to grow at 8% per year indefinitely. Assuming that JRN's risk is
unchanged by the expansion, the value of a share of JRN after the announcement is closest to ________.
A) $19.32
B) $12.75
C) $38.63
D) $25.50
Answer: A
Explanation: A) Two steps.
Step 1: Solve for rE:
Step 2: Solve for new stock price:
Diff: 2 Var: 50+

Skill: Analytical
Author: JN
17) You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to
retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining
50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings
will be invested in projects with an expected return of 20% per year. If Bean's equity cost of capital is 10%,
then the price of a share of Bean's stock is closest to ________.
A) $24.82
B) $16.54
C) $41.36
D) $66.18
Answer: C
Explanation: C)
Each g is calculated as the 20% return on the projects × the retention ratio.
Diff: 3 Var: 6
Skill: Analytical
Author: JN
18
18) Avril Synchronistics will pay a dividend of $1.20 per share this year. It is expected that this dividend
will grow by 3% each year in the future. What will be the current value of a single share of Avril's stock if
the firm's equity cost of capital is 16%?
A) $6.46
B) $6.92
C) $9.23
D) $10.15
Answer: C
Explanation: C) P0 = $1.20 / (0.16 - 0.03) = $9.23
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
19) Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend
will grow by 5% per year each year in the future. What will be the current value of a single share of
Spacefood's stock if the firm's equity cost of capital is 12%?
A) $24.00
B) $22.29
C) $30.86
D) $34.29
Answer: D
Explanation: D)
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
20) Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that this dividend
will grow by 4% per year each year in the future. The current price of Gremlin's stock is $23.50 per share.
What is Gremlin's equity cost of capital?
A) 11%
B) 12%
C) 14%
D) 16%
Answer: B
Explanation: B)
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
19
21) A company has stock which costs $41.50 per share and pays a dividend of $2.50 per share this year.
The company's cost of equity is 7%. What is the expected annual growth rate of the company's dividends?
A) 0.98%
B) 1.96%
C) 2.94%
D) 3.92%
Answer: A
Explanation: A)
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
22) Which of the following will NOT increase a company's dividend payments?
A) It can issue more shares.
B) It can increase its earnings.
C) It can decrease the number of shares outstanding.
D) It can increase its dividend payout rate.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
23) Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming
year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this
investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo
Transport?
A) $12.71
B) $14.83
C) $16.94
D) $21.18
Answer: D
Explanation: D) D1 = $2.00 × (1 - 0.1) = $1.8;
g = 0.1 × 0.25 = 0.025;
P0 = $1.8 / (0.11 - 0.025) = $21.18
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
20
24) Sunnyfax Publishing pays out all its earnings and has a share price of $37. In order to expand,
Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained
funds. Once the funds are reinvested, they are expected to grow at a rate of 13%. If the reinvestment does
not affect Sunnyfax's equity cost of capital, what is the expected share price as a consequence of this
decision?
A) $36.67
B) $41.90
C) $52.38
D) $62.86
Answer: C
Explanation: C) Cost of capital = $3/$37 = 0.08108108;
g = 0.33 × 0.13 = 0.0429;
P0 = $2 / (0.08108108 - 0.0429) = $52.38
Diff: 1 Var: 36
Skill: Analytical
Author: DS
25) Kirkevue Industries pays out all its earnings as dividends and has a share price of $27. In order to
expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest
the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the
equity cost of capital unchanged?
A) 1.48%
B) 0.14%
C) 0.17%
D) 0.15%
Answer: A
Explanation: A) rE1 = $2.15 / $27 = ;
Diff: 1 Var: 50+

Skill: Analytical
Author: DS
21
26) Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against
Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that
Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will
reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before
the development of the vaccine and are expected to grow by 40% per year for the next three years. After
this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years
from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what
is the value of a share of Sinclair Pharmaceuticals today?
A) $20.62
B) $25.78
C) $33.96
D) $33.51
Answer: B
Explanation: B) E3 = $3.0184; D3 = $2.2638
E4 = $3.16932; D4 = $2.37699;
Diff: 1 Var: 50+

Skill: Analytical
Author: DS
27) What is a major assumption about growth rate in the dividend-discount model?
Answer: It is assumed that the growth rate used in the dividend-discount model be constant in the
future.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
28) What is the relationship between the growth rate and the cost of equity implied in the dividend-
discount model?
Answer: For the dividend-discount model equation to be viable, the growth rate should be smaller than
the cost of equity because the model becomes meaningless if the growth rate is equal to or greater than
the cost of equity.
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Reflective Thinking Skills
Author: SS
22
29) Assuming everything else remains unchanged, how does a firm's decision to increase its dividend-
payout ratio affect its growth rate?
Answer: Increasing dividend-payout ratio will decrease the retention rate, thereby decreasing the growth
rate.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
30) Can the dividend-discount model handle negative growth rates?

Answer: Yes, the dividend-discount model can handle negative growth rates. The model works as long
as growth rate is smaller than the cost of equity and negative growth rate is smaller than the cost of
equity.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
31) How can the dividend-discount model handle changing growth rates?
Answer: Most firms have high growth rate during the early part of their existence, which gradually
tapers to the steady-state growth rate. We cannot apply the formula during the period while the growth
rate is changing. We can only apply it once the growth rate has stabilized to a constant rate.
Diff: 1 Var: 1
Skill: Conceptual
Author: SS
7.5 Limitations of the Dividend-Discount Model
1) Forecasting dividends requires forecasting the firm's earnings, dividend payout rate, and future share
count.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
2) Stocks that do not pay a dividend must have a value of $0.

Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
23
3) Which of the following is a limitation of the dividend-discount model?
A) It cannot handle negative growth rates.
B) It requires accurate dividend forecasts, which is not possible.
C) It requires that the growth rate always be higher than the required rate of return, which is not realistic.
D) It does not consider past earnings and performance.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
Author: WC
7.6 Share Repurchases and the Total Payout Model
1) Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0
million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to
repurchase shares. If Sultan's earnings are expected to grow by 5% per year, these payout rates do not
change, and Sultan's equity cost of capital is 10%, what is Sultan's share price?
A) $12.00
B) $24.00
C) $36.00
D) $60.00
Answer: D
Explanation: D)
Diff: 1 Var: 50+
Skill: Analytical
Author: DS
2) Which of the following models directly values all of the firm's equity, rather than a single share?
I. Dividend-discount model
II. Total payout model
III. Discounted cash flow model
A) I only
B) II only
C) III only
D) II and III
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
Author: DS
24
3) Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of
$800 million. Valence pays out 40% of its earnings in total—15% paid out as dividends and 25% used to
repurchase shares. If Valence's earnings are expected to grow by 7% per year, these payout rates do not
change, and Valence's equity cost of capital is 9%, what is Valence's share price?
A) $11.27
B) $22.54
C) $60.10
D) $75.12
Answer: D
Explanation: D)
Diff: 1 Var: 50+

Skill: Analytical
Author: DS
4) Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to
be $960 million. The firm's equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total:
20% paid out as dividends and 10% used to repurchase shares. If Chittenden's earnings are expected to
grow at a constant 3% per year, what is Chittenden's share price?
A) $3.74
B) $2.24
C) $7.47
D) $14.94
Answer: C
Explanation: C)
Diff: 1 Var: 50+

Skill: Analytical
Author: WC
25
Fundamentals of Corporate Finance 3rd Edition Berk Test Bank
5) Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641
million. The firm's equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out
as dividends and 20% used to repurchase shares. If Aaron's earnings are expected to grow at a constant
7% per year, what is Aaron's share price?
A) $12.48
B) $24.96
C) $37.44
D) $49.92
Answer: B
Explanation: B)
Price
Diff: 1 Var: 50+
Skill: Analytical
Author: WC
26
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7.1 Stock Basics

2) What are dividend payments?

8) What role do dividends play in stock investing?

3) A "round lot" consists of how many shares?

7.3 The Dividend-Discount Model

7.4 Estimating Dividends in the Dividend-Discount Model

4) Which of the following statements is FALSE?

7) Which of the following statements is FALSE?

9) Which of the following formulas is INCORRECT?

Diff: 2 Var: 50+

Step 2: Solve for new stock price:

Diff: 2 Var: 50+

Diff: 1 Var: 50+

Diff: 1 Var: 50+

30) Can the dividend-discount model handle negative growth rates?

7.5 Limitations of the Dividend-Discount Model

2) Stocks that do not pay a dividend must have a value of $0.

7.6 Share Repurchases and the Total Payout Model

Diff: 1 Var: 50+

Diff: 1 Var: 50+

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