Managerial Finance Chapter 6 Stock Valuation Questions and Answers

Managerial Finance Chapter 6 Stock Valuation Questions and Answers What is the primary role of a designated market maker (DMM)? Provide a two-sided market The voting procedure where you must control 50 percent plus one of the outstanding shares of stock to guarantee that you will win a seat on the board of directors is called _____ voting. Straight An agent who arranges security transactions among investors without maintaining an inventory of their own is called a: Broker Which one of the following represents the portion of a stock's rate of return that is attributable to the growth rate of the dividends? Capital gains yield A _____ is a form of equity security that has a stated liquidating value. Preferred stock A stock that pays a constant annual dividend will have a market price that: Decreases when the market rate of return increases Based on the dividend growth model, an increase in investors' required rate of return will: cause the market values of all stocks to decrease, all else held constant Staggered elections: help prevent takeovers Corporate dividends: are taxed at the personal level even though they are paid from after-tax income A stock quote shows a last price of 41.18, a P/E of 16, and a net change of −.38. Based on this information, which one of the following statements is correct? The earnings per share are equal to 1/16th of $41.18 Which one of the following statements concerning dealers and brokers in the financial markets is correct? A broker never assumes ownership of the securities being traded A stock report contains the following information: P/E 18.6, closing price 17.28, dividend .65, net change .17, and an ask of 17.35 × 200. Which one of the following statements is correct given this information? The closing price on the previous trading day was $17.11 In a stock market report, the open price represents the first trade of the day Which one of the following transactions occurs in the primary market? Delta, Inc., sold new Delta stock to David Denver Wool is owned by a group of shareholders who all vote independently and who all want personal control over the firm. There are three open seats and Danielle is one of six contenders. If straight voting is utilized and Danielle is a current shareholder, then she can only be assured of her election if she owns sufficient shares to control the entire election DOC just paid a dividend of $.46 a share. The dividends are expected to increase by 30 percent a year for the next two years and then increase by 2 percent annually thereafter. What is the current value of a share if the appropriate discount rate is 15 percent? $5.72 P2 = ($.46 × 1.3^2 × 1.02)/(.15 − .02) = $6.10 P0 = $.46 × 1.3/1.15 + [$.46 × 1.3^2 + $6.10]/1.15^2 = $5.72 The stock of Gonzalez Industries traditionally provides a rate of return of 11.7 percent. The company just paid an annual dividend of $2.81 per share and recently announced it will commence increasing its dividends by 3 percent each year. For this stock to return its traditional rate, what should the market price of this stock be? $33.27 P0 = [$2.81 × (1 + .03)]/(.117 − .03) Last week, Railway Cabooses paid its annual dividend of $1.12 a share. The company has been reducing its dividends by 4 percent each year. What is one share of stock worth at a required return of 17 percent? $5.12 P0 = {$1.12 × [1 + (−.04)]}/[.17 − (−.04)] = $5.12 Brandy Knits just paid an annual dividend of $1.42 per share and plans on decreasing this amount by 1 percent annually. What is the expected dividend for Year 6? $1.34 D6 = $1.42(1 − .01)^6 The Vineyard recently paid an annual dividend of $2.78. This dividend increases at 1.65 percent per year and currently sells for $42.19 a share. What is the rate of return? 8.35% R = $2.78 × 1.0165/$42.19 + .0165 Snider's Hardwoods has a dividend payout ratio of 45 percent, a return on assets of 9.4 percent, and a debt-equity ratio of .38. What is the firm's rate of growth? 7.13% g = (1 − .45) × .094 × (1 + .38) = .0713, or 7.13% Honore's earned net income $337,000 last year. It has an estimated 70,000 shares of stock outstanding, but they are not actively traded. Gila Corp., which is a similar firm with similar growth opportunities, has 185,000 shares of stock outstanding with a market price of $32.20 per share. Gila's earnings per share last year was $1.60. What is the estimated value of Honore's? $6,782,125 Estimated value = $32.20/$1.60 × $337,000 = $6,782,125 Duncan Street Mills is an all-equity firm with 28,000 shares of stock outstanding. The firm expects sales of $400,000 next year. Sales are expected to grow by 5 percent for the following two years and then level off to a constant 3 percent growth rate. Net cash flow varies in direct proportion to sales and is currently equal to 15 percent of sales. The required return for this firm is 16 percent. What is the estimated current value of one share of stock? $17.02 Shares of Masha stock are currently selling for $14.43. The last annual dividend paid was $1.61 a share, and dividends increase at a constant rate. If the market rate of return is 14 percent, what is the dividend growth rate? 2.56% $14.43 = [$1.61 × (1 + g)]/(.14 − g) g = .0256, or 2.56% Wilton's Market just announced its next annual dividend will be $1.62 a share with future dividends increasing by 2.2 percent annually. How much will one share of this stock be worth six years from now if the required return is 12.5 percent? $17.92 P6 = $1.62 × 1.022^6/(.125 − .022) = $17.92 What is the primary business of the NYSE? Attract and process order flow A market participant who buys and sells securities from their own inventory is called a dealer Which of these factors are most associated with a high PE ratio? Conservative accounting practices and low risk Which one of the following statements concerning preferred stock is correct? Preferred shareholders may be granted voting rights if preferred dividend payments remain unpaid Hentges Co. pays a constant annual dividend of $2.50 per share and has 1,000 shares of common stock outstanding. The company must declare each annual dividend before it becomes an actual liability. The underlying assumption of the dividend growth model is that a stock is worth the present value of the future income provided by that stock. Kate, an individual investor, sold 500 shares of Hewn Furniture stock on Monday. Levy, another individual investor, purchased those shares, although he never met Kate. You know for certain that this trade occurred in which market? Secondary market Last year, Grenville common stock had a rate of return of 15.84 percent, a fixed annual dividend of $2.65 a share, and a dividend yield of 2.7 percent. What was the rate of price appreciation on the stock? 13.14% g = 15.84% − 2.7% = 13.14% JulianCo common stock pays an annual dividend of $2.10 a share and is committed to maintaining a constant dividend. How much are you willing to pay for one share of this stock if your required return is 14 percent? $15.00 P0 = $2.10/.14 Ernst Electrical increases its annual dividend by 1.8 percent annually. The stock commands a market rate of return of 18 percent and sells for $19.07 a share. What is the expected amount of the next dividend? $3.09 $19.07 = D1/(.18 − .018) D1 = $3.09 An investor wants to purchase shares in a firm that has no growth opportunities but pays an annual dividend of $1.35. The market rate of return on similar securities is 12 percent. What is the maximum price the investor should pay for this stock? $11.25 $1.35/.12 = $11.25 Cassandra Chemical Corp. just paid an annual dividend of $2.69 a share. What is one share of this stock worth to you if the dividends increase by 5 percent annually and you require a rate of return of 12 percent? $40.35 P0 = [$2.69 × (1 + .05)]/(.12 − .05) P0 = $40.35 A common stock pays an annual dividend of $3.40 and sells for $51.20 a share. What is the total expected rate of return if the dividend yield represents 40 percent of the total return? 16.60% R = ($3.40/$51.20)/.40 = .1660, or 16.60% Dille, Inc., pays no dividend at the present time. In Years 2 and 3, the firm will pay annual dividends of $4 a share. After that, it will pay a constant $2 a share dividend indefinitely. What is this stock worth at a required return of 17 percent? $12.77 P3 = $2/.17 = $11.76 P0 = $4/1.17^2 + ($4 + 11.76)/1.17^3 = $12.77 Feltwater Furniture has 134,000 shares of stock outstanding. The firm expects to earn net income of $286,000 next year with annual increases of 4 percent per year thereafter. The firm pays out 70 percent of its net income in dividends. The required return is 16 percent. What is the share price? $12.45 Price per share = .70 × $286,000/134,000/(.16 − .04) = $12.45 Pavlos, Inc., is expecting a period of intense growth, so it has decided to reduce its annual dividend by 10 percent a year for the next three years. After that, it will maintain a constant dividend of $1.90 a share. Last year, the annual dividend was $2.70 a share. What is the market value of this stock if the required rate of return is 15 percent? $13.39 P3 = $1.90/.15 = $12.67 P0 = $2.70 × .90/1.15 + $2.70 × .90^2/1.15^2 + [$2.70 × .90^3 + $12.67]/1.15^3 = $13.39 The expected dividend yield is equal to Expected cash dividend / Current stock price The voting procedure where a shareholder grants authority to another individual to vote his/her shares is called __________ voting. Proxy The voting procedure whereby shareholders may cast all their votes for one candidate for the board of directors is called __________ voting. Cumulative Electronic communications networks (ECNs) act to increase liquidity in the financial markets. The owner of preferred stock is entitled to a distribution of income prior to the common shareholders. Theo owns 49,800 of the 120,000 outstanding shares of BBE, Inc. The share price is $28.64. Each share is granted one vote for each open seat on the board of directors. Currently, there are three open seats. Theo wants to be on the board and is assuming that no one, other than himself, will vote for him. How much additional money, if any, must he invest in BBE to guarantee his election if the firm uses a straight voting system? $292,156.64 Total number of shares needed = .5 × 120,000 + 1 = 60,001 shares Additional shares needed = 60,001 − 49,800 = 10,201 shares Additional cost to purchase shares = 10,201 × $28.64 = $292,156.64 Orville stock's last annual dividend was $1.10 a share. Dividends are expected to increase by 15 percent for the next two years and then increase at a constant 3 percent annually. The required return is 17.5 percent. What is the current value per share? $9.62 P2 = $1.10 × 1.15^2 × 1.03/(.175 − .03) = $10.33 P0 = $1.10 × 1.15/1.175 + [$1.10 × 1.15^2 + $10.33]/1.175^2 = $9.62