Reading 56: An Introduction to Security Valuation- LOS c(

discount, interpret, following, statements, investment

LOS c, (Part 2): Calculate and interpret the value of a common stock using the dividend discount model (DDM).

Q1. Which of the following statements about the constant growth dividend discount model (DDM) in its application to investment analysis is FALSE? The model:

A) is best applied to young, rapidly growing firms.

B) can’t be applied when g>K.

C) can’t handle firms with variable dividend growth.

Q2. A firm pays an annual dividend of $1.15. The risk-free rate (RF) is 2.5 percent, and the total risk premium (RP) for the stock is 7 percent. What is the value of the stock, if the dividend is expected to remain constant?

A) $25.00.

B) $16.03.

C) $12.10.

Q3. 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) Unable to calculate stock value because k_e < g.

B) $17.91.

C) $26.86.

Q4. 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 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.

C) 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.

Q5. 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) $121.79.

B) $34.95.

C) $26.64.

Q6. Which of the following is a shortcoming(s) of the constant growth dividend discount model?

A) Small differences in key assumptions can produce widely varying values.

B) All these choices are correct.

C) Firms with temporary high-growth expectations have characteristics that are inconsistent with model.

Q7. 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.

Q8. Assuming the risk-free rate is 5% and the expected return on the market is 12%, what is the value of a stock with a beta of 1.5 that paid a $2 dividend last year if dividends are expected to grow at a 5% rate forever?

A) $12.50.

B) $17.50.

C) $20.00.