For Final exam
1. Stock A has a required return of 10 percent. Its dividend is expected to grow at a constant rate of 7 percent per year. Stock B has a required return of 12 percent. Its dividend is expected to grow at a constant rate of 9 percent per year. Stock A has a price of $25 per share, while Stock B has a price of $40 per share. Which of the following statements is most correct?
a. The two stocks have the same dividend yield. *
b. If the stock market were efficient, these two stocks should have the same price.
c. If the stock market were efficient, these two stocks should have the same expected return.
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The company's beta is 1.2, the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price?
c. $25.00 *
4. McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to grow at a constant rate, g, forever. What is the growth rate, g, for this stock?
b. 6% *
ks = D1/P0 + g
g = ks - D1/P0
g = 0.11 - $1/$20 = 0.06 = 6%.
5. The last dividend paid by Klein Company was $1.00. Klein’s growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent forever. Klein’s required rate of return on equity (ks) is 12 percent. What is the current price of Klein’s common stock?
d. $50.16 *
P0 = [pic] + [pic] = $50.16.
6. You must estimate the intrinsic value of Gallovits Technologies’ stock. Gallovits’s end-of-year free cash flow (FCF) is expected to be $25 million, and it is expected to grow at a constant rate of 8.5% a year thereafter. The company’s WACC is 11%. Gallovits has $200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding. What is Gallovits' estimated intrinsic value per share of common stock?
d. $26.67 *
7. Campbell Co. is trying to estimate its weighted average cost of capital (WACC). Which of the following statements is most correct?
a. The after-tax cost of debt is generally cheaper than the after-tax cost of equity. *
b. Since retained earnings are readily available, the cost of retained earnings is generally lower than the cost of debt.
c. The after-tax cost of debt is generally more expensive than the before-tax cost of debt.
d. Statements a and c are correct.
8. Wyden Brothers has no retained earnings. The company uses the CAPM to calculate the cost of equity capital. The company’s capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company’s WACC?
a. A reduction in the market risk premium. *
b. An increase in the flotation costs associated with issuing new common stock.
c. An increase in the company’s beta.
d. An increase in expected inflation.
Statement a is true; the other statements are false. If RPM decreases, the cost of equity will be reduced. Answers b through e will all increase the company’s WACC.
9. Dick Boe Enterprises, an all-equity firm, has a corporate beta coefficient of 1.5. The financial...