invic

Which of the following would NOT be appropriate to value a firm with two expected growth stages? A(an):

A) Gordon growth model.

B) free cash flow model.

C) H-model.

---

The Gordon growth model would not be appropriate for a firm with two stages of growth but is useful to value a firm with steady slow growth.

invic

Which of the following would NOT be appropriate for the Gordon growth model?

A) Mature, slow growth automotive manufacturer.

B) High-tech start-up firm with no dividends.

C) Regulated utility company.

---

The Gordon growth model is inappropriate for a firm with supernormal growth that cannot be expected to continue. A multistage model is appropriate for such a firm.

invic

The Gordon growth model is well suited for:

A) utilities.

B) telecom companies.

C) biotech firms.

---

Gordon growth model is best suited to firms that have a stable growth comparable to or lower than the nominal growth rate in the economy and have well established dividend payout policies. Utilities, with their regulated prices, stable growth and high dividends, are particularly well suited for this model.

invic

If the growth rate in dividends is too high, it should be replaced with:

A) a growth rate closer to that of gross domestic product (GDP).

B) the average growth rate of the industry.

C) the growth rate in earnings per share.

---

A firm cannot, in the long term, grow at a rate significantly greater than the growth rate of the economy in which it operates. If the growth rate in dividends is too high, then it is best replaced by a growth rate closer to that of GDP.

invic

The Gordon growth model will NOT work when the:

A) growth rate is greater than or equal to the required rate of return.

B) required rate of return is greater than growth rate.

C) growth rate is less than the required rate of return.

---

The Gordon growth model, P0 = DPS1/ (r - g), will not work if the growth rate is greater than or equal to the required rate of return.

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.

---

The value of the preferred is $78:

V0 = ($100par × 7%) / 9% = $77.78

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.

---

The current value of the shares is $76.92:

V0 = ($100 × 0.05) / 0.065 = $76.92

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%.

---

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

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.

---

The value of the preferred is $147:

V0 = ($100par × 11%) / 7.5% = $146.67

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%.

---

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%