Practice problems for Bond and Stock valuation

# Practice problems for Bond and Stock valuation - Practice...

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Practice problems for Bond and Stock valuation Answer: c i . Assume an all equity firm has been growing at a 15% annual rate and is expected to continue to do so for 3 more years. At that time, growth is expected to slow to a constant 4% rate. The firm maintains a 30% payout ratio, and this year’s retained earnings net of dividends were \$1.4 million. The firm’s beta is 1.25, the risk-free rate is 8%, and the market risk premium is 4%. If the firm has 1 million shares outstanding, what is the market value of the firm’s common equity? a. \$ 6.41 million b. \$12.96 million c. \$ 9.17 million d. \$10.56 million e. \$ 7.32 million Answer: b ii . Mulroney Motors’ stock has a required return of 10% and its stock trades at \$50 per share. The year-end dividend, D 1 , is expected to be \$1.00 per share. After this payment, the dividend is expected to grow by 25% per year for the next three years. That is, D 4 = \$1.00(1.25) 3 = \$1.953125. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock’s expected constant growth rate after t = 4? In other words, what is X? a. 5.47% b. 6.87% c. 6.98% d. 8.00% e. 8.27% Answer: b iii . Club Auto Parts’ last dividend, D 0 , was \$0.50, and the company expects to experience no growth for the next 2 years. However, Club will grow at an annual rate of 5% in the third and fourth years, and, beginning with the fifth year, it should attain a 10% growth rate that it will sustain thereafter. Club has a required rate of return of 12%. What should be the price per share of Club stock at the end of the second year, 2 P ˆ ? a. \$19.98 b. \$25.08 c. \$31.21 d. \$19.48 e. \$27.55 Answer: e iv . Modular Systems Inc. just paid dividend D 0 , and it is expecting both earnings and dividends to grow by 0% in Year 2, by 5% in Year 3, and at a rate of 10% in Year 4 and thereafter. The required return on Modular is 15%, and it sells at its equilibrium price, P 0 = \$49.87. What is the

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expected value of the next dividend, D 1 ? a. It cannot be estimated without more data. b. \$1.35 c. \$1.85 d. \$2.35 e. \$2.85 Answer: e v . A stock is expected to pay a \$2.50 dividend at the end of the year (D 1 = \$2.50). The dividend is expected to grow at a constant rate of 6% a year. The stock’s beta is 1.2, the risk-free rate is 4%, and the market risk premium is 5%. What is the expected stock price eight years from today? a. \$105.59 b. \$104.86 c. \$133.97 d. \$ 65.79 e. \$ 99.62 Answer: e vi . Stock X has a required return of 10%, while Stock Y has a required return of 12%. Which of the following statements is CORRECT? a. Stock Y must have a higher dividend yield than Stock X. b. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X. c. If Stock X and Stock Y have the same current dividend and the same
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Practice problems for Bond and Stock valuation - Practice...

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