1 .The last dividend paid on a common stock was $2.00, thegrowth rate is 5% and investors require a 10% return. Using the infinite perioddividend discount model, calculate the value of the stock.
A)$42.00.
B)$40.00.
C)$13.33.
The correct answer was:A
2(1.05) / (0.10 - 0.05)= $42.00
2 . A firm’s cost ofequity capital is least accurately described as the:
A)ratio of the firm’snet income to its average book value.
B)minimum rate of returninvestors require to invest in the firm’s equity securities.
C)expected total returnon the firm’s equity shares in equilibrium.
The correct answer was:A
The ratio of the firm’snet income to its average book value is the firm’s return on equity, which canbe greater than, equal to, or less than the firm’s cost of equity. Cost ofequity for a firm can be defined as the expected equilibrium total return inthe market on its equity shares, or as minimum rate of return that investorsrequire as compensation for the risk of the firm’s equity securities.
3 . Baker Computerearned $6.00 per share last year, has a retention ratio of 55%, and a return onequity (ROE) of 20%. Assuming their required rate of return is 15%, how muchwould an investor pay for Baker on the basis of the earnings multiplier model?
A)$40.00.
B)$173.90.
C)$74.93.
The correct answer was C
g = Retention × ROE =(0.55) × (0.2) = 0.11
P0/E1 = 0.45 / (0.15 ?0.11) = 11.25
Next year's earnings E1= E0 × (1 + g) = (6.00) × (1.11) = $6.66
P0 = 11.25($6.66) =$74.93
4 . Assuming a discountrate of 15%, a preferred stock with a perpetual dividend of $10 is valued atapproximately:
A)$66.67.
B)$1.50.
C)$8.70.
The correct answer was:A
The formula for thevalue of preferred stock with a perpetual dividend is: D / kp, or 10.0 / 0.15 =$66.67.
5 . The price to bookvalue ratio (P/BV) is a helpful valuation technique when examining firms:
A)with older assetscompared to those with newer assets.
B)that hold primarilyliquid assets.
C)with the same stockprices.
The correct answer was B
P/BV analysis works bestfor firms that hold primarily liquid assets.
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