FIN 3400 Ch 8 SMARTBOOK - Complete Solutions (Verified)

FIN 3400 Ch 8 SMARTBOOK - Complete Solutions (Verified) Assume you are computing P0, which is the current price of a stock. What discount factor will you use to discount the dividend in year 3? (1 + i)^3 Which one of these defines the current value of a stock? Discounted value of both the future dividends and the future stock price What is the disadvantage of a market order? The execution price is unknown in advance. A stock is expected to pay a dividend of $2 in year 2, $3 in year 3, and sell for $40 at the end of year 3. The discount rate is 11 percent. Which one of these is the correct formula for computing the current stock price? P0 = $2/1.11^2 + [($3 + $40)/1.11^3] True or false: Stock valuation can really only be meaningfully viewed from a long-term perspective. True Which one of these best defines the dividend discount model? A stock valuation method based on the present value of all future dividends Which one of these applies to stock valuation? The value of a stock today equals the discounted value of the future expected cash flows. A firm just paid its annual dividend of $1.80 and expects to increase that dividend each year. The discount rate is 11 percent. Which one of these correctly identifies an error when computing the current value of this firm's stock? P0 = $1.80/(0.11 - 0.025); The value of D1 is incorrect as $1.80 equals D0. A stock is expected to pay annual dividends of $1.20 and sell for $42.60 three years from today. Which of these is the correct formula for computing the value of the stock today if the discount rate is 9 percent? P0 = ($1.20/1.09) + ($1.20/1.09^2) + [($1.20 + $42.60)/1.09^3] Which one of these best summarizes stock valuation? Stock valuation is an estimate of a stock's value given a certain set of assumptions. What is the key premise upon which the dividend discount model is based? All future cash flows from a stock are dividend payments. A firm just paid its annual dividend of $1.80 and expects to increase that dividend each year. The discount rate is 11%. Which one of these correctly identifies an error when computing the current value of this firm's stock? P0 = $2.02/(0.11 - 0.12); The growth rate exceeds it limitation for using this formula. The overall rate of growth for a firm and its industry is 3.5 percent. Which of these combinations of dividend growth rates are acceptable when computing the current value of the firm's stock? Short-run growth = 15 percent; Long-run growth = 3 percent A stock just paid its annual dividend of $1.20. Future dividends are expected to increase by 2 percent annually and the discount rate is 9 percent. Which of these is the correct formula for computing the current stock price? P0 = ($1.20 × 1.02)/(0.09 - 0.02) Which of these accurately recaps dividend growth estimations and limitations as they apply to the dividend growth model? Select all that apply. -Dividends can grow quickly in the short-run but cannot exceed the overall economic growth rate over the long-run. -Dividend growth can be estimated based on historical data, dividend trends, or analyst's forecasts. Which of these is a limitation that applies to the constant-growth dividend model? g i A firm just paid an annual dividend of $1.40 and increases that dividend by 2 percent each year. How do you find the price of the firm's stock at year 4 if the discount rate is 13 percent? P4 = ($1.40 × 1.02^5)/(0.13 - 0.02) Which one of these generally applies to preferred stock? Higher dividend yields than common stock issued by the same issuer Which of these applies to the valuation of a preferred stock? Select all that apply. -Preferred dividends are assumed to be a constant dollar amount. -Preferred dividend payments are assumed to be infinite. What is the basic assumption of the constant-growth model? If the dividend amount changes each year, it does so by a constant percentage. A stock is expected to pay a dividend of $1.42 next year and increase that amount by 3 percent annually thereafter. The discount rate is 12 percent. How do you compute the current price? P0 = $1.42/(0.12 - 0.03) A preferred stock has which of these characteristics? Zero dividend growth How can a preferred stock be valued? Select all that apply. -Preferred stock can be valued using the constant-growth model. Rationale: Preferred stock can be valued using the constant-growth model with a growth rate of zero. -Preferred stock can be valued as a perpetuity, PV = PMT/i Rationale: Preferred stock is a perpetuity. The dividend is the PMT and the discount rate per period is i. A preferred stock is currently selling for $68 a share. What will happen to the stock price if market interest rates increase? The stock price will decrease. How is the dividend yield on a constant-dividend preferred stock defined? Last four quarters of dividend income/Current stock price A stock has a dividend yield of 1.4 percent. What is the expected return if the growth rate is 4 percent? What if the growth rate is 8 percent? 5.4 percent; 9.4 percent Rationale: Expected return = 1.4% + 4% = 5.4%; Expected return = 1.4% + 8% = 9.4% How is the discount rate used to value a stock related to the expected return on the stock? Assume the stock price fairly reflects the stock's value. The discount rate should equal the expected rate of return. A stock just announced that its next annual dividend will be $1.02 and it expects to increase that dividend by 2.5 percent annually. The stock is currently selling for $28 a share. How do you compute the expected rate of return? i = ($1.02/$28) + 0.025 A preferred stock is currently selling for $68 a share. What must be the dividend if the interest rate is 7%? $4.76 Rationale: Div = P X i What is the definition of a growth stock? Stock of a company with above-average rates of increases in revenues, earnings, and/or dividends Assume a preferred stock pays a constant annual dividend. Which of these is a correct computation of the dividend yield? Select all that apply. Dividend yield = D/P0 Dividend yield = D0/P0 Dividend yield = D1/P0 A stock has an expected rate