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##### Foundations of Financial Management (10248) - Fall I, 2013 week 6

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Question;Foundations of;Financial Management (10248) - Fall I, 2013;Week 6 Questions/Problems;Brushy;Mountain Mining Company's ore reserves are being depleted, so its sales are;falling. Also, its pit is getting deeper each year, so its costs are rising. As;a result, the company's earnings and dividends are declining at the constant;rate of 4% per year. If D0=;$6 and rs= 18%, what;is the value of Brushy Mountain Mining's stock? Round your answer to the;nearest cent.;Problem 7-4;Preferred Stock Valuation;Nick's Enchiladas Incorporated has preferred stock outstanding;that pays a dividend of $3 at the end of each year. The preferred stock sells;for $40 a share. What is the stock's required rate of return? Round the answer;to two decimal places.;Problem 7-2;Constant Growth Valuation;?;eBook;?;Boehm Incorporated is expected to pay a $3.40 per share dividend;at the end of this year (i.e., D1=;$3.40). The dividend is expected to grow at a constant rate of 10% a year. The;required rate of return on the stock, rs, is 17%. What is the value;per share of the company's stock? Round your answer to the nearest cent.;Q;Which of the following statements is CORRECT?;a. The constant growth model takes into consideration the;capital gains investors expect to earn on a stock.;b. Two firms with the same expected dividend and growth;rates must also have the same stock price.;c. It is appropriate to use the constant growth model to;estimate a stock's value even if its growth rate is never expected to;become constant.;d. If a stock has a required rate of return rs =;12%, and if its dividend is expected to grow at a constant rate of 5%, this;implies that the stock's dividend yield is also 5%.;e. The price of a stock is the present value of all expected;future dividends, discounted at the dividend growth rate.;Q;If in the opinion of a given investor a stock's expected returnexceedsits;required return, this suggests that the investor thinks;a. the stock should be sold.;b. the stock is a good buy.;c. management is probably not trying to maximize the price;per share.;d. dividends are not likely to be declared.;e. the stock is experiencing supernormal growth;Companies can issue different;classes of common stock. Which of the following statements concerning stock;classes is CORRECT?;a. All firms have several classes of common stock.;b. All common stocks, regardless of class, must have the;same voting rights.;c. All common stocks fall into one of three classes: A, B;and C.;d. Some class or classes of common stock are entitled to;more votes per share than other classes.;Which of the following statements is CORRECT, assuming stocks;are in equilibrium?;a. Assume that the required return on a given stock is 13%.;If the stock's dividend is growing at a constant rate of 5%, its expected;dividend yield is 5% as well.;b. A required condition for one to use the constant growth;model is that the stock's expected growth rate exceeds its required rate of;return.;c. The dividend yield on a constant growth stock must equal;its expected total return minus its expected capital gains yield.;d. A stock's dividend yield can never exceed its expected;growth rate.;e. Other things held constant, the higher a company's beta;coefficient, the lower its required rate of return.;A share of common stock just paid a dividend of $1.00. If the;expected long-run growth rate for this stock is 5.4%, and if investors;required rate of return is 11.4%, what is the stock price?;a. $17.13;b. $16.70;c. $17.57;d. $16.28;e. $18.01;Problem 7-5;Nonconstant Growth Valuation;A company currently pays a dividend of $3.25 per share, D0= 3.25. It is estimated that the company's dividend will grow at;a rate of 23% percent per year for the next 2 years, then the dividend will;grow at a constant rate of 6% thereafter. The company's stock has a beta equal;to 1.55, the risk-free rate is 7.5 percent, and the market risk premium is 6;percent. What is your estimate is the stock's current price? Round your answer;to the nearest cent.;$;?;Check My Work(3;remaining);A stock is expected to pay a year-end dividend of $2.00, i.e., D1= $2.00. The dividend is expected to decline at a rate of 5% a;year forever (g =-5%). If;the company is in equilibrium and its expected and required rate of return is;15%, which of the following statements is CORRECT?;a. The company's current stock price is $20.;b. The company's dividend yield 5 years from now is expected;to be 10%.;c. The company's expected capital gains yield is 5%.;d. The constant growth model cannot be used because the;growth rate is negative.;e. The company's expected stock price at the beginning of;next year is $9.50.;Problem 7-10;Rates of Return and Equilibrium;?;eBook;?;The beta;coefficient for Stock C is bC= 0.6, and that for;Stock D is bD= - 0.6. (Stock D's beta is negative;indicating that its rate of return rises whenever returns on most other stocks;fall. There are very few negative-beta stocks, although collection agency and;gold mining stocks are sometimes cited as examples.);a. If the risk-free rate;is 8%and the expected rate of return on an average stock is 11%, what are the;required rates of return on Stocks C and D? Round the answers to two decimal;places.;1. rC=?;2. rD=?;b. For Stock C, suppose;the current price, P0, is $25, the next expected dividend, D1;is $1.50, and the stock's expected constant growth rate is 4%. Is the stock in;equilibrium? Explain, and describe what would happen if the stock is not in;equilibrium.-Select-;I;II;III;IV;V;Item 3;I.In this situation, the expected rate of return = 9.80%. However;the required rate of return is 10%. Investors will seek to buy the stock;raising its price to $25.86. At this price, the stock will be in equilibrium.II.In this situation, the expected rate;of return = 10%. However, the required rate of return is 9.80%. Investors will;seek to sell the stock, raising its price to $25.86. At this price, the stock;will be in equilibrium.III.In this situation, the expected rate;of return = 9.80%. However, the required rate of return is 10%. Investors will;seek to sell the stock, raising its price to $25.86. At this price, the stock;will be in equilibrium.IV.In this situation, the expected rate;of return = 10%. However, the required rate of return is 9.80%. Investors will;seek to buy the stock, raising its price to $25.86. At this price, the stock;will be in equilibrium.V.In this situation, both the expected;rate of return and the required rate of return are equal. Therefore, the stock;is in equilibrium at its current price.;For a stock to be in equilibrium;that is, for there to be no long-term pressure for its price to depart from its;current level, then;a. the past realized return must be equal to the expected;return during the same period.;b. the expected return must be equal to both the required;future return and the past realized return.;c. the expected future return must be less than the most;recent past realized return.;d. the expected future returns must be equal to the required;return.;e. the required return must equal the realized return in all;periods.;Problem 7-15;Constant Growth Stock Valuation;?;eBook;?;Investors require a 15% rate of return on Brooks Sisters' stock;(rs= 15%).;a. What;would the value of Brooks's stock be if the previous dividend was D0= $3.25 and if investors expect dividends to grow at a constant;compound annual rate of (1) - 2%, (2) 0%, (3) 7%, or (4) 12%? Round your;answers to the nearest cent.;1. $;2. $;3. $;4. $;b. Using;data from part a, what is the Gordon (constant growth) model's value for Brooks;Sisters's stock if the required rate of return is 15% and the expected growth;rate is (1) 15% or (2) 23%? Are these reasonable results? Explain.;1. -Select-;Yes, it is reasonable result.;No, it is not reasonable result, because in this case the value of stock is undefined.;No, it is not reasonable result, because in this case the value of stock is negative, which is nonsense.;Item 5;2. -Select-;Yes, it is reasonable result.;No, it is not reasonable result, because in this case the value of stock is undefined.;No, it is not reasonable result, because in this case the value of stock is negative, which is nonsense.;Item 6;c. Is it;reasonable to expect that a constant growth stock would have g > rs?-Select-;Yes;No;Item 7;Problem 7-16;Equilibrium Stock Price;?;eBook;?;The risk-free rate of return, rRF, is 11%, the required rate of return on the market, rM;15%, and Schuler Company's stock has a beta coefficient of 1.7.;a. If the;dividend expected during the coming year, D1, is $2.00, and if g is;a constant 1.75%, then at what price should Schuler's stock sell? Round your;answer to the nearest cent.;$;b. Now;suppose the Federal Reserve Board increases the money supply, causing a fall in;the risk-free rate to 6% and rMto 13%.;How would this affect the price of the stock? Round your answer to the nearest;cent.;$;c. In;addition to the change in part b, suppose investors' risk aversion declines;this fact, combined with the decline in rRF, causes rMto fall to 8%. At what price would Schuler's stock sell? Round;your answer to the nearest cent.;$;d.;Suppose Schuler has a change in management. The new group;institutes policies that increase the expected constant growth rate to 7%.;Also, the new management stabilizes sales and profits, and thus causes the beta;coefficient to decline from 1.7 to 0.7. Assume that rRFand rMare equal;to the values in part c. After all these changes, what is Schuler's new;equilibrium price? (Note:D1goes to $2.10.) Round your answer to the nearest cent.;$;The expected return on Natter Corporation's stock is 14%. The;stock's dividend is expected to grow at a constant rate of 8%, and it currently;sells for $50 a share. Which of the following statements is CORRECT?;a. The stock's dividend yield is 7%.;b. The stock's dividend yield is 8%.;c. The current dividend per share is $4.00.;d. The stock price is expected to be $54 a share one year;from now.;e. The stock price is expected to be $57 a share one year;from now.

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