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