SET 3 ANSWERS to PRACTICE QUESTIONS Common Stocks (Valuation And

SET 3 ANSWERS to PRACTICE QUESTIONS Common Stocks (Valuation and Management), Efficient Markets, Market/Economy, Industry, Company Analysis Chapters 10-15

CHAPTER 10:

1. a

2. a

3. b

4. b

5. b (d is incorrect—it is the value for someone using the equation)

6. b (dividends, not earnings)

7. b ([$1.20(1.07)] / [.14 - .07]) Note: $1.20 = current dividend

8. e (k = Dl/P0 + g; therefore, g = k – Dl/P0; g = .15 - .05 = .10

9. b ($20 / [.15 – .10] = 400)

10. d (beta = .85 because BLC is 15% less risky; k = 6 + .85 [8] = 12.8;

P0 = D1 / [k – g] = $1.50 / [12.8 - .07] = $25.86)

11. a (D0 = $2.55; D1 = $2.75; P0 = $2.75 / [.15 - .08] = $39.29)

12. b (k = 6 + 1.0 [8] = 14%; P0 = $1.20(1.07) / [.14 - .07] = $18.34)

13. d (D1 = Earnings X payout ratio = $4.00 X .3 = $1.20; k = 5 + 1.1[14 - 5] = 14.9;

P0 = $1.20 / [14.9 - .08] = $17.39)

14. d (g = estimated growth rate, therefore use 6%; D1 = $2(1.06) = $2.12;

P0 = $2.12 / [.16 - .06] = $21.20)

15. b (k = expected return = D1/P0 + g; 2/40 + .07 = 12%)

16. a (g = 8% [found by rule of 72]; D1 = $1.00 X 1.08 = $1.08;

P0 = $1.08 / [.15 - .08] = $15.43)

17. b (expected return = D1/P0 + g = 14.9; required return of 15.1 is greater than

expected return; therefore, you cannot justify buying the stock)

18. c (value is determined by a procedure regardless of holding period)

19. c ([$2 / (.15 - .07)] = [$2 / (.16 - .08)]; D1 stays the same)

20. c (D1 = $1.50 X 1.05 = $1.575; dividend yield = $1.575 / $15.75 = 10%;

capital gains yield = the growth rate; Note: the sum of the two must be 15%)

21. e (D0 = $2.00; D1 = $2 X .95 = $1.90; D2 = $1.90 X .95 = $1.81; D3 = $1.81 X

.95 = $1.72; D4 = $1.72 x .95 = $1.63; D5 = $1.63 x .95 = $1.55;

P4 = D5 / [k – g] = $1.55 / (k – [-.05]) = $1.55 / [.14 + .05] = $8.16)

22. e (P0 = $2.00 (1/1.14) + $1.50 (1/(1.14)2) + $2.00 (1/(1.14)3) + $3.50 (1/(1.14)4) +

($3.50(1.08) / [.14 - .08)]) X (1/(1.14)4) = $43.62)

23. c (multiple growth rate company; D0 = $2.00; D1 = $2.28; D2 = $2.60;

D3 = $2.96; PV of D1 = $1.93; PV of D2 = $1.87; PV of D3 = $1.80;

sum of these 3 present values = $5.60; constant growth rate is 6%;

P3 = D4 / [k-g;]; D4 = $2.96 x 1.06 = $3.14; P3 = $3.14 / [.18 - .06] = $26.15;

PV of $26.15 = $15.92; $15.92 + $5.60 = $21.52)

(NOTE: round off error can account for a few cents difference)

24. b (k = 7 + 2[11 – 7] = 15%); D1 = $3(1.20) = $3.60; D2 = $3.60(1.20) = $4.32;

D3 = $4.32(1.10) = $4.75; PV of D1 and D2 = $6.40;

P2 = D3 / [k – g] = $4.75 / [.15 - .10] = $95; PV of P2 = $71.83;

P0 = $71.83 + $6.40 = $78.23;

Dividend yield = $3.60 / $78.23 = 4.6%)

25. b

26. d

27. c (P/E = [D/E] / (k – g) = .75 / [.16 - .06] = 7.5)

28. a (if 70% is retained, 30% is paid out, therefore Earnings must be

$1.50 / .3 = $5.00; k = 8 + 2 [12 – 8] = .16;

P0 = $1.50 (1.10) / [.16 - .10] = $27.50

P/E = $27.50 / $5.50 = $5

Note: E0 = $5.00 and E1 = $5.00(1.10) = $5.50

29. c

CHAPTER 11

30. c (pessimism leads to an increase)

31. a (risk-free rate + stock’s risk premium)

32. d

33. b

34. d

35. b

36. a

37. c

38. c (the top-down approach)

39. b (rising, not falling)

CHAPTER 12

40. d

41. c

42. b

43. c

44. c

45. b

46. a

47. a

48. c (all have not been refuted)

49. c

50. c

51. d

CHAPTER 13

52. c (stock prices tend to lead the economy)

53. d

54. d

55. (E1 = $30; D1 = $30 X .4 = $12; k = 9 + 8 = 17%;

P0 = $12 / [.17 - .10] = $171.43)

56. b

57. c (can be calculated using estimated data)

58. c

59. a

60. d (market tends to lead economy)

61. d

CHAPTER 14

62. b

63. b

64. c

65. a

66. a

67. a

68. a

69. c

70. c

71. b

72. b

73. b

CHAPTER 15

74. b

75. a

76. b

77. d

78. a (.15 x 2)

79. d (.3 x 1.5)

80. c

81. c

82. b (ROE = .1845 x 2.278; EPS = BVps x ROE)

83. d ($10 x .10 = $1)

84. d (g = ROE x retention rate)

85. c

86. c (should be Total Assets / Stockholders Equity)

87. a

88. c

89. c (D1 = $2 X .10 = $2.20; P0 = $2.20 / [.20 - .10] = $22)

90. b

91. b

92. a (negative numbers count the same as positive, therefore choose largest)

93. c

94. d (minimum expected return; NOTE: a is correct because it does not specify stock required rate of return or market required rate of return)

95. c

96. c

97. c

98. b

99. a

100. d ($2 / $4 = .5 payout; .5 / [.16 - .06] = 5)