invic

Ambiance Company has a current market price of $42, a current dividend of $1.25 and a required rate of return of 12%. All earnings are paid out as dividends. What is the present value of Ambiance’s growth opportunities (PVGO)?

A) $38.85.

B) $31.58.

C) $16.71.

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The PVGO is $31.58:

PVGO = $42 – ($1.25 / 0.12) = $31.58

invic

A firm has the following characteristics:

• Current share price $100.00.
• Current earnings $3.50.
• Current dividend $0.75.
• Growth rate 11%.
• Required return 13%.

Based on this information and the Gordon growth model, what is the firm’s justified trailing price to earnings (P/E) ratio?

A) 11.9.

B) 8.9.

C) 11.3.

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The justified trailing P/E is 11.9:

P0 / E0 = [($0.75)(1 + 0.11)/$3.50] / (0.13 – 0.11) = 11.8929

invic

A firm has the following characteristics:

• Current share price $100.00.
• One-year earnings $3.50.
• One-year dividend $0.75.
• Required return 13%.
• Justified leading price to earnings 10.

Based on the dividend discount model, what is the firm’s assumed growth rate?

A) 12.4%.

B) 10.9%.

C) 8.6%.

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The assumed growth rate is 10.9%:

P0 / E1 = ($0.75/$3.50) / (0.13 – g) = 10, g = 10.86%

invic

A firm has the following characteristics:

• Current share price $100.00.
• Next year's earnings $3.50.
• Next year's dividend $0.75.
• Growth rate 11%.
• Required return 13%.

Based on this information and the Gordon growth model, what is the firm’s justified leading price to earnings (P/E) ratio?

A) 11.3.

B) 10.7.

C) 8.7.

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The justified leading P/E is 10.7:

P0 / E1 = ($0.75 / $3.50) / (0.13 – 0.11) = 10.714

invic

Stan Bellton, CFA, is preparing a report on TWR, Inc. Bellton’s supervisor has requested that Bellton include a justified trailing price-to-earnings (P/E) ratio based on the following information:
Current earnings per share (EPS) = $3.50.
Dividend Payout Ratio = 0.60.
Required return for TRW = 0.15.
Expected constant growth rate for dividends = 0.05.
TWR’s justified trailing P/E ratio is closest to:

A) 4.0.

B) 6.3.

C) 6.0.

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The dividend payout ratio (1 – b) is 0.60, so the retention ratio (b) is 0.4.

invic

If an asset’s beta is 0.8, the expected return on the equity market is 10.0%, and the appropriate discount rate for the Gordon model is 9.0%, what is the risk-free rate?

A) 5.00%.

B) 6.50%.

C) 2.50%.

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Required return = risk-free rate + beta (expected equity market return – risk-free rate)
9% = risk-free rate + 0.8(0.10 – risk-free rate)
9% = 0.08 + 0.2(risk-free rate)
1% / 0.2 = risk-free rate = 0.05 or 5%

invic

What is the value of a fixed-rate perpetual preferred share (par value $100) with a dividend rate of 11.0% and a required return of 7.5%?

A) $147.

B) $152.

C) $138.

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The value of the preferred is $147:

V0 = ($100par × 11%) / 7.5% = $146.67

invic

If the value of an 8%, fixed-rate, perpetual preferred share is $134, and the par value is $100, what is the required rate of return?

A) 8%.

B) 7%.

C) 6%.

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The required rate of return is 6%: V0 = ($100par × 8%) / r = $134, r = 5.97%

invic

A $100 par, perpetual preferred share pays a fixed dividend of 5.0%. If the required rate of return is 6.5%, what is the current value of the shares?

A) $100.00.

B) $76.92.

C) $88.64.

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The current value of the shares is $76.92:

V0 = ($100 × 0.05) / 0.065 = $76.92

invic

What is the value of a fixed-rate perpetual preferred share (par value $100) with a dividend rate of 7.0% and a required return of 9.0%?

A) $71.

B) $56.

C) $78.

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The value of the preferred is $78:

V0 = ($100par × 7%) / 9% = $77.78