1 .Whichof the following statements about the constant growth dividend discount model(DDM) is least accurate?
A)The constant growthDDM is used primarily for stable mature stocks.
B)In the constantgrowth DDM dividends are assumed to grow at a constant rate forever.
C)For the constantgrowth DDM to work, the growth rate must exceed the required return on equity.
The correct answer wasC
Dividends grow atconstant rate forever.
Constant growth DDM isused for mature firms.
k must be greater thang.
2 . Compared topreferred stock, common stock is most likely to:
A)exhibit a lowerstandard deviation of returns.
B)pay more frequentdividends.
C)provide a higheraverage return.
The correct answer wasC
Common stock is morerisky than preferred stock and is expected to provide higher average returns.Preferred stock promises fixed periodic dividends. Common stock can bedividend-paying or non-dividend paying and the dividends are at management’sdiscretion.
3 . What is the valueof a stock that paid a $0.25 dividend last year, if dividends are expected togrow at a rate of 6% forever? Assume that the risk-free rate is 5%, theexpected return on the market is 10%, and the stock's beta is 0.5.
A)$16.67.
B)$17.67.
C)$3.53.
The correct answer wasB
The discount rate iske = 0.05 + 0.5(0.10 ? 0.05) = 0.075. Use the infinite period dividend discountmodel to value the stock. The stock value = D1 / (ke – g) = (0.25 × 1.06) /(0.075 – 0.06) = $17.67.
4 . The yield on acompany’s 7.5%, $50 par preferred stock is 6%. The value of the preferred stockis closest to:
A)$12.50.
B)$62.50.
C)$50.00.
The correct answer wasB
The preferred dividendis 0.075($50) = $3.75. The value of the preferred = $3.75 / 0.06 = $62.50.
5 . An argumentagainst using the price-to-sales (P/S) valuation approach is that:
A)P/S ratios are notas volatile as price-to-earnings (P/E) multiples.
B)P/S ratios do notexpress differences in cost structures across companies.
C)sales figures arenot as easy to manipulate or distort as earnings per share (EPS) and bookvalue.
The correct answer wasB
P/S ratios do notexpress differences in cost structures across companies. Both remainingresponses are advantages of the P/S ratios, not disadvantages.
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