Daniel Hernandez

DISCOUNTED DIVIDEND VALUATION

1. Joshua wants to purchase the stock of Dingo Ltd, which is currently trading at $31.29. He
expects the companys next years earnings to be $2.08, at which time he expects to be able to
sell the stock for $33.80. Given a required rate of return of 12% and that the company retains
40% of its earnings, the stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued

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2. Diego Investments stock is currently trading at $22.45 per share. The company recently paid
a dividend of $1.80, which is expected to grow at a rate of 5.5% forever. Given that the stock
is fairly valued, the required rate of return on the stock is closest to:
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A. 13.51%
B. 11.39%
C. 13.96%

3. James Doyle is contemplating investing in the stock of Pyramid Construction, which is

currently trading for $62.25 per share. The companys recently paid a dividend of $2.80 per
share. Analysts forecast that the companys dividend will grow at a rate of 14% for the next 5
years after which the dividend growth rate will stabilize at 6% into perpetuity. Given a
required rate of return of 12%, the stock is currently most likely:
A. Undervalued
B. Overvalued
C. Fairly valued

4. Daniela wants to estimate the price of Alpha Ltds stock. The company is expected to pay a
dividend of $2.50 next year, which is expected to grow at a constant rate of 4.5% forever.
Given a required rate of return of 12.5%, the intrinsic value of the stock is closest to:
A. $20.25
B. $31.25
C. $32.66

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Use the following information to answer Questions 5 to 7:

An analyst gathered the following information regarding Pluto Inc:
Expected EPS for 2011 = $4.25
Retention rate = 0.4
Required return = 11%
Current stock price = $54.85
Dividends are paid out at the end of the year and are expected to grow at a rate of 5.5% forever.

5. The intrinsic value of the stock at the end of 2010 is closest to:
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A. $46.36
B. $77.27
C. $30.91

6. The present value of growth opportunities is closest to:

A. $31.67
B. $16.21
C. $7.72

7. The fraction of the companys leading P/E ratio that comes from present value of growth
opportunities is closest to:
A. 3.81%
B. 29.55%
C. 34.97%

8. Caroline wants to invest in the stock of Getsmart Pharma, which is currently trading at
$67.20. The company is expected to pay dividends of $2.80, $3.36, $4.03, $4.84 and $5.81 at
the end of each of the next five years. Analysts expect the stock to trade at $79.50 after five
years. Given a required rate of return of 11%, the stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued

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9. Tamara Ltds stock is currently trading at $38.25 per share. The company recently paid a
dividend of $1.50, which is expected to grow at a constant rate forever. Given a required rate
of return of 10% and that the stock is fairly valued, the implied growth rate is closest to:
A. 5.85%
B. 6.08%
C. 13.40%

10. Chris is considering investing in the stock of Gamma Corporation, which is currently trading
at $13.80 per share. The stock recently paid a dividend of $2.25; however due to poor
industry outlook, dividends are expected to decline at a rate of 7% forever. Given a required
rate of return of 12%, the stock is most likely:
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A. Undervalued
B. Overvalued
C. Fairly valued

Use the following information to answer Questions 11 and 12:

An analyst gathered the following information regarding Alturius Inc.
Current market price per share = $29.48
Current year EPS = $3.18
Current year dividend per share = $1.272
Required rate of return on equity = 12%
Dividends are expected to grow at a rate of 6.5% forever.

11. The companys justified leading P/E ratio is closest to:

A. 7.75
B. 7.27
C. 10.91

12. Based on the justified trailing P/E ratio, the stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued

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13. Octimus Inc has a $100 par fixed-rate perpetual preferred stock outstanding with a dividend
of 7%. The stock is currently trading for $56.36. Given a required rate of return of 11%, the
stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued

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14. Sasha Hemmington is analyzing the stock of Jeremy Traders. She expects the companys
current annual dividend of $1.20 to grow at a rate of 12% for the next five years and then
stabilize at a long-term growth rate of 6%. The companys trailing P/E ratio at the end of the
initial high-growth period is expected to be 10, and its retention rate is expected to be 40%.
The required rate of return on the companys stock is 13%. The terminal value of the stock at
the end of Year 5, based on the Gordon growth model and the earnings multiple approach is
closest to:
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Gordon Growth Model

Earnings Multiple Approach

$32.02

$35.25

$34.14

$52.87

$32.02

$52.87

15. Juan Diaz is contemplating investing in the stock of Indigo Inc, whose stock is currently
trading for $18.99 per share. The company has recently commenced its operations and is not
expected to pay any dividends for the next 4 years. The companys EPS currently stands at
$2.75 and is expected to grow at a rate of 16% per annum over the next 4 years. Beginning in
Year 5, the companys growth rate is expected to fall to 5% and remain at that level into
perpetuity. From Year 5 onwards, Indigo is also expected to retain 60% of its earnings and
distribute the rest as dividends. Given a required rate of return of 12%, the companys stock is
currently most likely:
A. Undervalued
B. Overvalued
C. Fairly valued

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Use the following information to answer Questions 16 and 17:

An analyst gathered the following information regarding Beta Corporation:

Current dividend per share = $2.18

Next years expected dividend growth rate of 30% is expected to decline linearly over the
following 8 years to a long-term constant growth rate of 6%.
Required rate of return on the companys stock is 11%.

16. The value of the companys stock today is closest to:

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A. $41.86
B. $98.54
C. $88.07
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17. What proportion of the stocks value is attributable to the extraordinary growth?
A. 41.86%
B. 42.47%
C. 47.52%

18. An analyst gathers the following information regarding Finesse Capital.

Current price = $75
Current dividend = $3.50
Short term supernormal growth rate = 10%
Long term sustainable growth rate = 5%
The supernormal growth in dividends is expected to linearly decline over a period of 6 years.
The required rate of return on the stock is closet to:
A. 10.60%
B. 10.83%
C. 15.60%

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19. Joanna Kaprikova is evaluating the stock of Maya Company which is currently trading at
$100.76 per share. The stock recently paid a dividend of $2.25 per share, which is expected to
grow at a rate of 25% for the next 2 years, followed by a 17% growth rate for 3 years, after
which it is expected to stabilize at a perpetual constant growth rate of 8%. Given a required
rate of return of 12%, the stock is most likely:
A. Undervalued
B. Fairly valued
C. Overvalued

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20. The stock of Jet Corporation recently paid a dividend of $3.08 per share, which is expected to
grow at a rate of 20% for the next 3 years and then decline linearly over the next 10 years to a
constant growth rate of 4%. Given a required rate of return of 12%, the value of stock is
closest to:
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A. $97.75
B. $122.41
C. $88.42

21. The stock of Tulip Inc is currently trading at $78.30 per share. The company recently paid a
dividend of $1.50 per share. Next years expected dividend growth rate of 12% is expected to
decline linearly over the next 6 years to a long-term constant growth rate of 5%. Given that
the stock is fairly priced, the required rate of return on the stock is closest to:
A. 2.41%
B. 7.41%
C. 14.41%

22. An analyst gathered the following information regarding a company:

Return on assets = 18%
Asset turnover = 13%
Dividend payout ratio = 60%
Equity multiplier = 1.35
The companys sustainable growth rate is closest to:
A. 9.72%
B. 14.58%
C. 12.64%

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Daniel Hernandez

DISCOUNTED DIVIDEND VALUATION

1. Joshua wants to purchase the stock of Dingo Ltd, which is currently trading at $31.29. He
expects the companys next years earnings to be $2.08, at which time he expects to be able to
sell the stock for $33.80. Given a required rate of return of 12% and that the company retains
40% of its earnings, the stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued
Answer: C
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D 1 = $2.08 (1 0.4) = $1.248

V 0 = (D 1 + P 1 ) / (1 + r)1
V 0 = (1.248 + 33.80) / 1.12 = $31.29
The stock is currently trading at its intrinsic value of $31.29, so it is fairly valued.

2. Diego Investments stock is currently trading at $22.45 per share. The company recently paid
a dividend of $1.80, which is expected to grow at a rate of 5.5% forever. Given that the stock
is fairly valued, the required rate of return on the stock is closest to:
A. 13.51%
B. 11.39%
C. 13.96%
Answer: C
V 0 = D 1 / (r g)
22.45 = (1.80 1.055) / (r 0.055)
r = 13.96%

3. James Doyle is contemplating investing in the stock of Pyramid Construction, which is

currently trading for $62.25 per share. The companys recently paid a dividend of $2.80 per
share. Analysts forecast that the companys dividend will grow at a rate of 14% for the next 5
years after which the dividend growth rate will stabilize at 6% into perpetuity. Given a
required rate of return of 12%, the stock is currently most likely:
A. Undervalued
B. Overvalued

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C. Fairly valued
Answer: A
D1
D2
D3
D4
D5
D6

= 2.80 1.14 = $3.192

= 2.80 1.142 = $3.6389
= 2.80 1.143 = $4.1483
= 2.80 1.144 = $4.7291
= 2.80 1.145 = $5.3912
= 5.3912 1.06 = $5.7147

V 5 = D 6 / (r g) = 5.7147 / (0.12 0.06) = $95.245

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[CF] [2nd] [CE|C]

[Enter] []
3.192 [Enter] [] []
3.6389 [Enter] [] []
4.1483 [Enter] [] []
4.7291 [Enter] [] []
100.6362 [Enter]
[NPV] 12 [Enter] [] [CPT]
NPV = $68.8127
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Since the market price of the stock is less than its intrinsic value, it is undervalued.

4. Daniela wants to estimate the price of Alpha Ltds stock. The company is expected to pay a
dividend of $2.50 next year, which is expected to grow at a constant rate of 4.5% forever.
Given a required rate of return of 12.5%, the intrinsic value of the stock is closest to:
A. $20.25
B. $31.25
C. $32.66
Answer: B
V 0 = D 1 / (r g)
V 0 = 2.50 / (0.125 0.045) = $31.25

Use the following information to answer Questions 5 to 7:

An analyst gathered the following information regarding Pluto Inc:
Expected EPS for 2011 = $4.25
Retention rate = 0.4
Required return = 11%

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Current stock price = $54.85

Dividends are paid out at the end of the year and are expected to grow at a rate of 5.5% forever.

5. The intrinsic value of the stock at the end of 2010 is closest to:
A. $46.36
B. $77.27
C. $30.91
Answer: A
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D 2011 = $4.25 (1 0.4) = $2.55

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V 2010 = 2.55 / (0.11 0.055) = $46.36

6. The present value of growth opportunities is closest to:

A. $31.67
B. $16.21
C. $7.72
Answer: B
No-growth value per share = E 1 / r = 4.25 / 0.11 = $38.6364
Present value of growth opportunities = Market price No-growth value per share
Present value of growth opportunities = 54.85 38.6364 = $16.21

7. The fraction of the companys leading P/E ratio that comes from present value of growth
opportunities is closest to:
A. 3.81%
B. 29.55%
C. 34.97%
Answer: B
Leading P/E ratio of the firm = 54.85 / 4.25 = 12.9059
P/E PVGO = 16.21 / 4.25 = 3.8141
Fraction of the companys leading P/E ratio attributable to growth opportunities:
= 3.8141 / 12.9059 = 29.55%

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8. Caroline wants to invest in the stock of Getsmart Pharma, which is currently trading at
$67.20. The company is expected to pay dividends of $2.80, $3.36, $4.03, $4.84 and $5.81 at
the end of each of the next five years. Analysts expect the stock to trade at $79.50 after five
years. Given a required rate of return of 11%, the stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued
Answer: B
TI BA II Plus calculator keystrokes:
Daniel Hernandez

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[CF] [2nd] [CE|C]

[Enter] []
2.80 [Enter] [] []
3.36 [Enter] [] []
4.03 [Enter] [] []
4.84 [Enter] [] []
85.31 [Enter]
[NPV] 11 [Enter] [] [CPT]
NPV = $62.01
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The stock is currently trading at a price which is higher than its intrinsic value, so it is
overvalued.

9. Tamara Ltds stock is currently trading at $38.25 per share. The company recently paid a
dividend of $1.50, which is expected to grow at a constant rate forever. Given a required rate
of return of 10% and that the stock is fairly valued, the implied growth rate is closest to:
A. 5.85%
B. 6.08%
C. 13.40%
Answer: A
V 0 = [D 0 (1 + g)] / (r g)
38.25 = [1.50 (1 + g)] / (0.10 g)
3.825 38.25g = 1.50 + 1.50g
g = 5.85%

10. Chris is considering investing in the stock of Gamma Corporation, which is currently trading
at $13.80 per share. The stock recently paid a dividend of $2.25; however due to poor
industry outlook, dividends are expected to decline at a rate of 7% forever. Given a required
rate of return of 12%, the stock is most likely:

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A. Undervalued
B. Overvalued
C. Fairly valued
Answer: B
V 0 = D 1 / (r g)
V 0 = [2.25 (1 0.07)] / [0.12 (0.07)] = $11.01

Use the following information to answer Questions 11 and 12:

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An analyst gathered the following information regarding Alturius Inc.

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Current market price per share = $29.48

Current year EPS = $3.18
Current year dividend per share = $1.272
Required rate of return on equity = 12%
Dividends are expected to grow at a rate of 6.5% forever.

11. The companys justified leading P/E ratio is closest to:

A. 7.75
B. 7.27
C. 10.91
Answer: B
Justified leading P/E = (1 b) / (r g)
Dividend payout ratio = D / E = 1.272 / 3.18 = 0.4
Justified leading P/E = 0.4 / (0.12 0.065) = 7.27

12. Based on the justified trailing P/E ratio, the stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued
Answer: B
Justified trailing P/E = (0.40 1.065) / (0/12 0.065) = 7.75

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Trailing P/E based on market price = 29.48 / 3.18 = 9.27

Since, the companys trailing P/E based on the market price is greater than its justified
trailing P/E, it is overvalued.

13. Octimus Inc has a $100 par fixed-rate perpetual preferred stock outstanding with a dividend
of 7%. The stock is currently trading for $56.36. Given a required rate of return of 11%, the
stock is most likely:
A. Undervalued
B. Overvalued
C. Fairly valued
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Answer: A
Dividend = 0.07 $100 = $7
Value of preferred stock = 7 / 0.11 = $63.64
The stocks current market price is lower than its intrinsic value, therefore, it is undervalued.

14. Sasha Hemmington is analyzing the stock of Jeremy Traders. She expects the companys
current annual dividend of $1.20 to grow at a rate of 12% for the next five years and then
stabilize at a long-term growth rate of 6%. The companys trailing P/E ratio at the end of the
initial high-growth period is expected to be 10, and its retention rate is expected to be 40%.
The required rate of return on the companys stock is 13%. The terminal value of the stock at
the end of Year 5, based on the Gordon growth model and the earnings multiple approach is
closest to:
Gordon Growth Model

Earnings Multiple Approach

$32.02

$35.25

$34.14

$52.87

$32.02

$52.87

Answer: A
Terminal value based on the Gordon growth model:
P 5 = D 6 / (r g)
P 5 = [(1.20 1.125) 1.06)] / (0.13 0.06) = $32.02
Terminal value based on the earnings multiple approach:
D 5 = 1.20 1.125 = $2.1148
D 5 = E 5 Payout rate

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E 5 = 2.1148 / (1 0.4) = $3.5247

P5 = P5 / E5 E5
P 5 = 10 3.5247 = $35.25

15. Juan Diaz is contemplating investing in the stock of Indigo Inc, whose stock is currently
trading for $18.99 per share. The company has recently commenced its operations and is not
expected to pay any dividends for the next 4 years. The companys EPS currently stands at
$2.75 and is expected to grow at a rate of 16% per annum over the next 4 years. Beginning in
Year 5, the companys growth rate is expected to fall to 5% and remain at that level into
perpetuity. From Year 5 onwards, Indigo is also expected to retain 60% of its earnings and
distribute the rest as dividends. Given a required rate of return of 12%, the companys stock is
currently most likely:
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A. Undervalued
B. Overvalued
C. Fairly valued
Answer: C
E 4 = 2.75 1.164 = $4.9793
E 5 = 4.9793 1.05 = $5.2283
D 5 = 5.2283 (1 0.6) = $2.0913
V 4 = D 5 / (r g) = 2.0913 / (0.12 0.05) = $29.8757
V 0 = 29.8757 / 1.124 = $18.99

Use the following information to answer Questions 16 and 17:

An analyst gathered the following information regarding Beta Corporation:

Current dividend per share = $2.18

Next years expected dividend growth rate of 30% is expected to decline linearly over the
following 8 years to a long-term constant growth rate of 6%.
Required rate of return on the companys stock is 11%.

16. The value of the companys stock today is closest to:

A. $41.86
B. $98.54
C. $88.07
Answer: C

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V 0 = {[D 0 (1 + g L )] / (r g L )} + {[D 0 H (g S g L )] / (r g L )}
V 0 = {[2.18 (1 + 0.06)] / (0.11 0.06)} + {[2.18 8/2 (0.30 0.06)] / (0.11 0.06)}
V 0 = $88.072

17. What proportion of the stocks value is attributable to the extraordinary growth?
A. 41.86%
B. 42.47%
C. 47.52%
Answer: C
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Value attributable to extraordinary growth = {[D 0 H (g S g L )] / (r g L )}

Value attributable to extraordinary growth = [2.18 8/2 (0.30 0.06)] / (0.11 0.06)
Value attributable to extraordinary growth = $41.856
Proportion of total value = 41.856 / 88.072 = 47.52%

18. An analyst gathers the following information regarding Finesse Capital.

Current price = $75
Current dividend = $3.50
Short term supernormal growth rate = 10%
Long term sustainable growth rate = 5%
The supernormal growth in dividends is expected to linearly decline over a period of 6 years.
The required rate of return on the stock is closet to:
A. 10.60%
B. 10.83%
C. 15.60%
Answer: A
r = (D 0 /P 0 )[(1+ g L ) + H(g S g L )] + g L
r = (3.50/75) [1.05 + (6/2)(0.10-0.05)] + 0.05 = 10.60%

19. Joanna Kaprikova is evaluating the stock of Maya Company which is currently trading at
$100.76 per share. The stock recently paid a dividend of $2.25 per share, which is expected to
grow at a rate of 25% for the next 2 years, followed by a 17% growth rate for 3 years, after
which it is expected to stabilize at a perpetual constant growth rate of 8%. Given a required
rate of return of 12%, the stock is most likely:

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A. Undervalued
B. Fairly valued
C. Overvalued
Answer: B
D1
D2
D3
D4
D5
D6
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= 2.25 1.25 = $2.8125

= 2.25 1.252 = $3.5156
= 3.5156 1.17 = $4.1133
= 3.5156 1.172 = $4.8125
= 3.5156 1.173 = $5.6307
= 5.6306 1.08 = 6.0810

V 5 = 6.0810 / (0.12 0.08) = $152.025

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[CF] [2nd] [CE|C]

[Enter] []
2.8125 [Enter] [] []
3.5156 [Enter] [] []
4.1133 [Enter] [] []
4.8125 [Enter] [] []
157.6556 [Enter]
[NPV] 12 [Enter] [] [CPT]
NPV = $100.7680
Since the stocks current price ($100.76) is the same as its intrinsic value ($100.76), it is
fairly valued.

20. The stock of Jet Corporation recently paid a dividend of $3.08 per share, which is expected to
grow at a rate of 20% for the next 3 years and then decline linearly over the next 10 years to a
constant growth rate of 4%. Given a required rate of return of 12%, the value of stock is
closest to:
A. $97.75
B. $122.41
C. $88.42
Answer: A
D 1 = 3.08 1.20 = $3.696
D 2 = 3.08 1.202 = $4.4352
D 3 = 3.08 1.203 = $5.3222
V 3 = [D 3 (1 + g L ) / (r g L )] + [D 3 H (g S g L )] / (r g L )]
V 3 = [5.3222 (1 + 0.04) / (0.12 0.04)] + [5.3222 (10/2) (0.20 0.04)] / (0.12 0.04)
V 3 = $122.4116

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[CF] [2nd] [CE|C]

[Enter] []
3.696 [Enter] [] []
4.4352 [Enter] [] []
127.9428 [Enter]
[NPV] 12 [Enter] [] [CPT]
NPV = $97.7541

21. The stock of Tulip Inc is currently trading at $78.30 per share. The company recently paid a
dividend of $1.50 per share. Next years expected dividend growth rate of 12% is expected to
decline linearly over the next 6 years to a long-term constant growth rate of 5%. Given that
the stock is fairly priced, the required rate of return on the stock is closest to:
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A. 2.41%
B. 7.41%
C. 14.41%
Answer: B
Required return = {(D 0 / P 0 ) [(1 + g L ) + H (g S g L )]} + g L
Required return = {(1.50 / 78.30) [(1 + 0.05) + 6/2 (0.12 0.05)]} + 0.05
Required return = 7.4138%

22. An analyst gathered the following information regarding a company:

Return on assets = 18%
Asset turnover = 13%
Dividend payout ratio = 60%
Equity multiplier = 1.35
The companys sustainable growth rate is closest to:
A. 9.72%
B. 14.58%
C. 12.64%
Answer: A
Sustainable growth rate = ROA Retention rate Equity multiplier
Sustainable growth rate = 0.18 (1 0.60) 1.35 = 9.72%

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