prashantsahni

If a preferred stock that pays a $11.50 dividend is trading at $88.46, what is the market’s required rate of return for this security?

A) 11.76%.

B) 13.00%.

C) 7.69%.

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From the formula: ValuePreferred Stock = D / kp, we derive kp = D / ValuePreferred Stock = 11.50 / 88.46 = 0.1300, or 13.00%.

prashantsahni

A company has 6% preferred stock outstanding with a par value of $100. The required return on the preferred is 8%. What is the value of the preferred stock?

A) $92.59.

B) $100.00.

C) $75.00.

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The annual dividend on the preferred is $100(.06) = $6.00. The value of the preferred is $6.00/0.08 = $75.00.

prashantsahni

What is the value of a preferred stock that is expected to pay a $5.00 annual dividend per year forever if similar risk securities are now yielding 8%?

A) $40.00.

B) $60.00.

C) $62.50.

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$5.00/0.08 = $62.50.

prashantsahni

The preferred stock of the Delco Investments Company has a par value of $150 and a dividend of $11.50. A shareholder’s required return on this stock is 14%. What is the maximum price he would pay?

A) $150.00.

B) $54.76.

C) $82.14.

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Value of preferred = D / kp = $11.50 / 0.14 = $82.14

prashantsahni

An analyst projects the following pro forma financial results for Magic Holdings, Inc., in the next year:

• Sales of $1,000,000
• Earnings of $200,000
• Total assets of $750,000
• Equity of $500,000
• Dividend payout ratio of 62.5%
• Shares outstanding of 50,000
• Risk free interest rate of 7.5%
• Expected market return of 13.0%
• Stock Beta at 1.8

If the analyst assumes Magic Holdings, Inc. will produce a constant rate of dividend growth, the value of the stock is closest to:

A) $19

B) $104

C) $44

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Infinite period DDM: P0 = D1 / (ke – g)

D1	= (Earnings × Payout ratio) / average number of shares outstanding
	= ($200,000 × 0.625) / 50,000 = $2.50.
ke	=  risk free rate + [beta × (expected market return – risk free rate)]
ke	=  7.5% + [1.8 × (13.0% - 7.5%)] = 17.4%.
g	=    (retention rate × ROE)
		Retention = (1 – Payout) = 1 – 0.625 = 0.375.
		ROE  = net income/equity
				= 200,000/500,000 = 0.4
g	= 0.375 × 0.4 = 0.15.

P0 = D1 / (ke – g) = $2.50 / (0.174 - 0.15) = 104.17.

prashantsahni

A firm pays an annual dividend of $1.15. The risk-free rate (RF) is 2.5%, and the total risk premium (RP) for the stock is 7%. What is the value of the stock, if the dividend is expected to remain constant?

A) $25.00.

B) $12.10.

C) $16.03.

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If the dividend remains constant, g = 0.
P = D1 / (k-g) = 1.15 / (0.095 - 0) = $12.10

kim226

Given the following estimated financial results, value the stock of FishnChips, Inc., using the infinite period dividend discount model (DDM).

• Sales of $1,000,000.
• Earnings of $150,000.
• Total assets of $800,000.
• Equity of $400,000.
• Dividend payout ratio of 60.0%.
• Average shares outstanding of 75,000.
• Real risk free interest rate of 4.0%.
• Expected inflation rate of 3.0%.
• Expected market return of 13.0%.
• Stock Beta at 2.1.

The per share value of FishnChips stock is approximately: (Note: Carry calculations out to at least 3 decimal places.)

A) $26.86.

B) Unable to calculate stock value because ke < g.

C) $17.91.

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Here, we are given all the inputs we need. Use the following steps to calculate the value of the stock:First, expand the infinite period DDM:
DDM formula: P0 = D1 / (ke – g)

D1	= (Earnings × Payout ratio) / average number of shares outstanding
	= ($150,000 × 0.60) / 75,000 = $1.20
ke	= nominal risk free rate + [beta × (expected market return – nominal risk free rate)]
	Note: Nominal risk-free rate		= (1 + real risk free rate) × (1 + expected inflation) – 1
			= (1.04)×(1.03) – 1 = 0.0712, or 7.12%.
ke	= 7.12% + [2.1 × (13.0% − 7.12%)] = 0.19468
g	= (retention rate × ROE)
	Retention	= (1 – Payout) = 1 – 0.60 = 0.40.
	ROE	= (net income / sales)(sales / total assets)(total assets / equity)
		= (150,000 / 1,000,000)(1,000,000 / 800,000)(800,000 / 400,000)
		= 0.375
g	= 0.375 × 0.40 = 0.15

Then, calculate: P0 = D1 / (ke – g) = $1.20 / (0.19468 − 0.15) = 26.86.

kim226

Which of the following statements concerning security valuation is least accurate?

A) A stock to be held for two years with a year-end dividend of $2.20 per share, an estimated value of $20.00 at the end of two years, and a required return of 15% is estimated to be worth $18.70 currently.

B) A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $36.11.

C) A stock with an expected dividend payout ratio of 30%, a required return of 8%, an expected dividend growth rate of 4%, and expected earnings of $4.15 per share is estimated to be worth $31.13 currently.

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A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $37.33 using the DDM where Po = D1 / (k − g). We are given Do = $3.25, g = 3.5%, and k = 12.5%. What we need to find is D1 which equals Do × (1 + g) therefore D1 = $3.25 × 1.035 = $3.36 thus Po = 3.36 / (0.125 − 0.035) = $37.33.
In the answer choice where the stock value is $18.70, discounting the future cash flows back to the present gives the present value of the stock. the future cash flows are the dividend in year 1 plus the dividend and value of the stock in year 2 thus the equation becomes: Vo = 2.2 / 1.15 + (2.2 + 20) / 1.152 = $18.70
For the answer choice where the stock value is $31.13 use the DDM which is Po = D1 / (k − g). We are given k = 0.08, g = 0.04, and what we need to find is next year’s dividend or D1. D1 = Expected earnings × payout ratio = $4.15 × 0.3 = $1.245 thus Po = $1.245 / (0.08 − 0.04) = $31.13

kim226

Use the following information and the dividend discount model to find the value of GoFlower, Inc.’s, common stock.

• Last year’s dividend was $3.10 per share.
• The growth rate in dividends is estimated to be 10% forever.
• The return on the market is expected to be 12%.
• The risk-free rate is 4%.
• GoFlower’s beta is 1.1.

A) $34.95.

B) $121.79.

C) $26.64.

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The required return for GoFlower is 0.04 + 1.1(0.12 – 0.04) = 0.128 or 12.8%. The expect dividend is ($3.10)(1.10) = $3.41. GoFlower’s common stock is then valued using the infinite period dividend discount model (DDM) as ($3.41) / (0.128 – 0.10) = $121.79.

kim226

What is the value of a stock that paid a $0.25 dividend last year, if dividends are expected to grow at a rate of 6% forever? Assume that the risk-free rate is 5%, the expected return on the market is 10%, and the stock's beta is 0.5.

A) $16.67.

B) $3.53.

C) $17.67.

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The discount rate is ke = 0.05 + 0.5(0.10 − 0.05) = 0.075. Use the infinite period dividend discount model to value the stock. The stock value = D1 / (ke – g) = (0.25 × 1.06) / (0.075 – 0.06) = $17.67.