Chapter 10: Valuation and Rates of Return

Question 1

Price of bonds =

Answer 1

PV of interest + PV of Principal Payments

(discount each at rate) (1 + Y)^n

Yield to maturity / required rate of return

Question 2

What is the yield to maturity

Answer 2

aka discount rate is bondholder required rate of return

Question 3

Increase (decrease) in premium = ___ bond price

Answer 3

Lower / (higher)

Question 4

Impact of time on bond price

Answer 4

Long time for above par = lower price as time increase

Long time for below par = higher price

Question 5

Preferred stock valuation

Answer 5

Represents perpetuity, no maturity date
fixed dividend
no ownership

Price = annual dividend / required rate

YTM = Kp = Dp / Pp

Question 6

Price to earning ratio

Answer 6

Multiplier applied to current earnings to determine value of share of stock in the market.

Influenced by:
Earnings and sales growth of firm.
Risk (or volatility in performance).
Debt-equity structure of firm.
Dividend policy.
Quality of management.

Question 7

Firms w bright expectations - trade at _____ P/E Ratios

Answer 7

High

Question 8

stock eps: $3, and P/E ratio 15 …market value =

Answer 8

45

Question 9

3. Variable growth in dividends (common stock value)

Answer 9

Take present value of dividends during exceptional growth period.
Determine price of stock at end of supernormal growth period by taking.
Present value of normal, constant dividends that follow supernormal growth period.
Discount the price to the present.
Add to present value of supernormal dividends.

Question 10

A company’s dividend is expected to grow at 20% for the next six years. After that, the growth is expected to be 3% forever. If the required return is 10%, what is the value of the stock at time 6? The dividend just paid was $1.

What is the value today

Answer 10

$43.94

today: 33.03

Question 11

If the current dividend (D0) is $3.00 and the growth rate is 6%. How much will the dividend be at Time 5?

Answer 11

Explanation
Dt=D0×(1+g)t

D5=D0×(1+g)5

D5=$3.00×(1+.06)5

D5=$3.00×1.3382

D5=$4.015

Question 12

Suppose we are interested in the price of a stock in five years, P5. We just paid a dividend of $2.20 and the growth rate is 4%. The required return is 12%. What is the price of the stock in five years?

Answer 12

We first need the dividend at Time 5, D5. Because the dividend just paid $2.20 and the growth rate is 4% per year, D4, is:

D5 =2.20×1.045=2.20×1.2167=$2.6766

From the dividend growth model, we get the price of the stock in five years:

P5=[D5×(1+g)] (R−g)=($2.6766×1.04)(.12−.04)=2.7837.08=$34.80

Question 13

A higher interest rate (discount rate) would

Answer 13

reduce the price of corporate bonds.

reduce the price of preferred stock.

reduce the price of common stock.

Question 14

An increase in the riskiness of a particular security would affect

Answer 14

the risk premium for that security.

the total required return for the security.

investors’ willingness to buy the security.

Question 15

The required return by investors is directly influenced by all of the following except:

inflation
U.S. Treasury rates
Dividends
Risk

Answer 15

Dividends

Question 16

A 20-year bond pays 9% on a face value of $1,000. If similar bonds are currently yielding 6%, what is the market value of the bond? Use annual analysis.

Answer 16

Over $1,300

Question 17

Star Corporation issued bonds two years ago with a 7% coupon rate. The bonds are currently trading for $928 in the market. Which of the following most likely has occurred since the time of issue?

Answer 17

infaltion increase

Question 18

A bond that has a yield to maturity greater than its coupon interest rate will sell for a price

Answer 18

below par.

Question 19

The growth rate for the firm’s common stock is 7%. The firm’s preferred stock is paying an annual dividend of $3. What is the preferred stock price if the required rate of return is 8%?

Answer 19

$37.50

Question 20

An issue of preferred stock is paying an annual dividend of $2.50. The growth rate for the firm’s common stock is 5%. What is the preferred stock price if the required rate of return is 8%?

Answer 20

31.25

Question 21

The dividend on preferred stock is most similar to

Answer 21

a common stock with no growth in dividends.

Question 22

If expected dividends grow at 5.25% and the appropriate discount rate is 7.5%, what is the value of a stock with an expected dividend one year from now of $1.00?

Answer 22

Po=D1(Ke−g)

= $1.00(0.075 − 0.0525) = $44.44

Question 23

If a company’s stock price (P0) goes up, and nothing else changes, Ke (the required rate of return) should

Answer 23

go down

Question 24

If expected dividends grow at 7% and the appropriate discount rate is 9%, what is the value of a stock with an expected dividend one year from now of $1.00?

Answer 24

50

Question 25

The value of a common stock is based on its

Answer 25

value of future benefits to the holder.