RobertA

An investor computes the current value of a firm’s shares to be $34.34, based on an expected dividend of $2.80 in one year and an expected price of the share in one year to be $36.00. What is the investor’s required rate of return on this investment?

A) 10%.

B) 11%.

C) 13%.

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The required return = [($36.00 + $2.80) / $34.34 ] – 1 = 0.13 or 13%.

RobertA

An investor projects the price of a stock to be $16.00 in one year and expected the stock to pay a dividend at that time of $2.00. If the required rate of return on the shares is 11%, what is the current value of the shares?

A) $16.22.

B) $14.11.

C) $15.28.

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The value of the shares = ($16.00 + $2.00) / (1 + 0.11) = $16.22

RobertA

Given an equity risk premium of 3.5%, a forecasted dividend yield of 2.5% on the market index and a U.S. government bond yield of 4.5%, what is the consensus long-term earnings growth estimate?

A) 8.0%.

B) 10.5%.

C) 5.5%.

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Equity risk premium = forecasted dividend yield + consensus long term earnings growth rate – long-term government bond yield.Therefore,
Consensus long term earnings growth rate =
Equity risk premium - forecasted dividend yield + long-term government bond yield
Consensus long term earnings growth rate = 3.5% - 2.5% + 4.5% = 5.5%

RobertA

A firm pays a current dividend of $1.00 which is expected to grow at a rate of 5% indefinitely. If current value of the firm’s shares is $35.00, what is the required return applicable to the investment based on the Gordon dividend discount model (DDM)?

A) 8.00%.

B) 8.25%.

C) 7.86%.

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The Gordon DDM uses the dividend for the period (t + 1) which would be $1.05.
$35 = $1.05 / (required return – 0.05)
Required return = 0.08 or 8.00%

RobertA

If the expected return on the equity market is 10%, the risk-free rate is 3%, and an asset’s beta is 0.6, what is the appropriate equity risk premium for the asset in applying the Gordon growth model?

A) 6.40%.

B) 4.20%.

C) 9.00%.

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The asset’s equity risk premium is equal to it’s beta times the difference between the expected return on the equity market and the risk-free rate. Equity Risk Premium = 0.6(0.10 − 0.03) = 0.042 or 4.2%.

RobertA

GreenGrow, Inc., has current dividends of $2.00, current earnings of $4.00 and a return on equity of 16%. What is GreenGrow’s sustainable growth rate?

A) 9%.

B) 6%.

C) 8%.

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GreenGrow’s sustainable growth rate is 8%.

g = [1 – ($2/$4)](0.16) = 8%

RobertA

Sustainable growth is the rate that earnings can grow:

A) without additional purchase of equipment.

B) indefinitely without altering the firm's capital structure.

C) with the current assets.

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Sustainable growth is the rate of earnings growth that can be maintained indefinitely without the addition of new equity capital.

RobertA

The sustainable growth rate, g, equals:

A) pretax margin divided by working capital.

B) dividend payout rate times the return on assets.

C) earnings retention rate times the return on equity.

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The formula for sustainable growth is: g = b × ROE, where g = sustainable growth, b = the earnings retention rate, and ROE equals return on equity.

RobertA

In computing the sustainable growth rate of a firm, the earnings retention rate is equal to:

A) Dividends / required rate of return.

B) 1 − (dividends / assets).

C) 1 − (dividends / earnings).

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Earnings retention rate = 1 − (dividends / earnings).

RobertA

Dynamite, Inc., has current earnings of $26, current dividend of $2, and a returned on equity of 18%. What is its sustainable growth?

A) 16.62%.

B) 14.99%.

C) 13.37%.

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g = [1 − ($2 / $26)]0.18 = 16.62%