1 . Two investors, CraigTower and Erin Gray, own 100 shares each of the same company. Tower receives aquarterly dividend while Gray does not. This is most likely because Tower:
A)owns common shareswhile Gray owns preferred shares.
B)purchased his sharesafter Gray purchased her shares.
C)owns a differentclass of stock than Gray.
The correct answer wasC
Different classes ofcommon stocks can have different features with respect to dividends, stocksplits, voting power and seniority if the firm’s assets are liquidated. If Grayowns preferred shares, she would be more likely to receive a dividend thanTower’s common shares. If Gray hadpurchased shares before an ex-dividend date and Tower purchased the same classof shares after that ex-dividend date, Gray would receive a dividend that Towerdid not.
2 . A firm is expectedto have four years of growth with a retention ratio of 100%. Afterwards thefirm’s dividends are expected to grow 4% annually, and the dividend payoutratio will be set at 50%. If earnings per share (EPS) = $2.4 in year 5 and therequired return on equity is 10%, what is the stock’s value today?
A)$13.66.
B)$30.00.
C)$20.00.
The correct answer was:A
Dividend in year 5 =(EPS)(payout ratio) = 2.4 × 0.5 = 1.2
P4 = 1.2 / (0.1 ?0.04) = 1.2 / 0.06 = $20
P0 = PV (P4) = $20 /(1.10)4 = $13.66
3 . A firm has anexpected dividend payout ratio of 48 percent and an expected future growth rateof 8 percent. What should the firm's price to earnings ratio (P/E) be if therequired rate of return on stocks of this type is 14 percent and what is theretention ratio of the firm?
P/E ratio Retentionratio
A) 6.5 52%
B) 6.5 48%
C) 8.0 52%
The correct answer wasC
8.0 52%
P/E = (dividend payoutratio)/(k - g)
P/E = 0.48/(0.14 -0.08) = 8
The retention ratio =(1 - dividend payout) = (1 - 0.48) = 52%
4 . An analystgathered the following data:
§ An earnings retention rate of 40%.
§ An ROE of 12%.
§ The stock's beta is 1.2.
§ The nominal risk free rate is 6%.
§ The expected market return is 11%.
Assuming next year'searnings will be $4 per share, the stock’s current value is closest to:
A)$26.67.
B)$33.32.
C)$45.45.
The correct answer wasB
Dividend payout = 1 ?earnings retention rate = 1 ? 0.4 = 0.6
RS = Rf + β(RM ? Rf) =0.06 + 1.2(0.11 ? 0.06) = 0.12
g = (retentionrate)(ROE) = (0.4)(0.12) = 0.048
D1 = E1 × payout ratio= $4.00 × 0.60 = $2.40
Price = D1 / (k – g) =$2.40 / (0.12 – 0.048) = $33.32
5 . With which of thefollowing types of equity shares does the investor typically have the greatestvoting power?
A)Common shares.
B)Participatingpreference shares.
C)Unsponsoreddepository receipts.
The correct answer was:A
While common shareshave voting rights, preference shares typically do not. With unsponsoreddepository receipts, the depository bank retains the right to vote the shares.
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