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CHAPTER 5- VALUING STOCKS

1. A stock paying $5 in annual dividends sells now for $80 and has an expected return of
14%. What might investors expect to pay for the stock one year from now?
A) $82.20
B) $86.20
C) $87.20
D) $91.20

Answer: B Difficulty: Medium Page: 139, 1st paragraph.

Div 1 + P1 − Po
Expected return =
Po
$5 + P1− $80
14% =
$80
$11.20 = P1 – $75
$86.20 = P1

2. What should be the price for a common stock paying $3.50 annually in dividends if the
growth rate is zero and the discount rate is 8%?
A) $22.86
B) $28.00
C) $42.00
D) $43.75

Answer: D Difficulty: Medium Page: 144, 1st paragraph.


Div 3.50
Po = = = $43.75
r .08

3. What constant growth rate in dividends is expected for a stock valued at $32.00 if next
year’s dividend is forecast at $2.00 and the appropriate discount rate is 13%?
A) 5.00%
B) 6.25%
C) 6.75%
D) 15.38%

Answer: C Difficulty: Medium Page: 145, 1st paragraph.


2.00
$32.00 =
.13 − g
$4.16 – 32g = $2.00
$2.16 = 32 g
.0675 = g
6.75% = g

4. If next year’s dividend is forecast to be $5.00, the constant growth rate is 4%, and the
discount rate is 16%, then the current stock price should be:
A) $31.25
B) $40.00
C) $41.67
D) $43.33

Answer: D Difficulty: Medium Page: 145, 1st paragraph.


$5.00
Po =
.16 −.04
$5.00
$41.67 =
.12

5. ABC common stock is expected to have extraordinary growth of 20% per year for two
years, at which time the growth rate will settle into a constant 6%. If the discount rate
is 15% and the most recent dividend was $2.50, what should be the current share
price?
A) $31.16
B) $33.23
C) $37.42
D) $47.77

Answer: C Difficulty: Hard Page: 148, 2nd paragraph.


2 2
$2.50(1.2) $2.50(1.2) 2.50(1.2) (1.06)
Po = + 2 + 2
1.15 1.15 (.15 −.06)(1.15)
$3.00 $3.60 $3.82
= + +
1.15 1.3225 .09(1.3225 )
= $2.61 + 2.72 + 32.09
= $37.42

6. What is the plowback ratio for a firm that has earnings per share of $12.00 and pays
out $4.00 per share as dividends?
A) 25.00%
B) 33.33%
C) 66.67%
D) 75.00%
Answer: C Difficulty: Medium Page: 149, 4th paragraph.
plowback = 1 - payout ratio
$4.00
=1–
$12.00
= 1 – .33
≈ .67

7.What price would you expect to pay for a stock with 13% required rate of return, 4% rate of
dividend growth, and an annual dividend of $2.50 which will be paid tomorrow?
A) $27.78
B) $30.28
C) $31.10
D) $31.39

Answer: D Difficulty: Hard Page: 145, 1st paragraph.


D1
Po = Do +
k −g
$2.50(1.04 )
= $2.50 +
.13 −.04
$2.60
= $2.50 +
.09
= $2.50 + $28.89
= $31.39

8.What rate of return is expected from a stock that sells for $30 per share, pays $1.50
annually in dividends, and is expected to sell for $33 per share in one year?
A) 5.00%
B) 10.00%
C) 14.09%
D) 15.00%

Answer: D Difficulty: Medium Page: 145, 1st paragraph.


DIV P1 − Po
Expected Return = +
Po Po
1.50 33.00 − 30.00
= +
30.00 30.00
= .05 + .10
= .15 = 15%

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