Investments+quiz+3-key-1.docx

Investments FINN 353 Quiz 3 KEY Name ________________________________ Roll # ___________________________

Question # Answer C 1 B 2 E 3 C 4 B 5 D 6 C 7 B 8 C 9 B 10 Question # 11, 12&13 are to be answered in the spaces provided after the questions.

Quiz 3 1. The ______ is a common term for the market consensus value of the required return on a stock. A. dividend payout ratio B. intrinsic value C. market capitalization rate D. plowback rate E. None of these is correct 2. If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to A. V= (Expected Dividend Per Share in Year 1)/k B. V= (Expected EPS in Year 1)/k C. V= (Treasury Bond Yield in Year 1)/k D. V= (Market return in Year 1)/k E. None of these is correct 3. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A. $23.91 B. $24.11 C. $26.52 D. $27.50 E. None of these is correct .10 = (42 − P + 3.50)/P; .10P = 42 − P + 3.50; 1.1P = 45.50; P = 41.36. 4. The growth in dividends of Music Doctors, Inc. is expected to be 8%/year for the next two years, followed by a growth rate of 4%/year for three years; after this five year period, the growth in dividends is expected to be 3%/year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were $2.75. What should the stock sell for today? A. $8.99 B. $25.21 C. $39.71 D. $110.00 E. None of these is correct

Calculations are shown below

P5 = 3.7164/(.11 − .03) = $46.4544; PV of P5 = $46.4544/(1.11)5 = $27.5684; PO = $12.1449 + $27.5684 = $39.71 5. According to James Tobin, the long run value of Tobin's Q should tend toward A. 0. B. 1. C. 2. D. infinity. E. None of these is correct. 6. SGA Consulting had a FCFE of $3.2M last year and has 3.2M shares outstanding. SGA's required return on equity is 13% and WACC is 11.5%. If FCFE is expected to grow at 8.5% forever, the intrinsic value of SGA's shares are ___________. A. $21.60 B. $26.56 C. $244.42 D. $24.11 E. None of these is correct $3.2M/3.2M = $1.00 FCFE per share; 1.00*1.085 = 1.085; 1.085/(.13 − .085) = 24.11 7. Which of the following formulas is INCORRECT? A) P0 =

+

+ ... +

B) P0 = C) re = D) P0 = Answer: C 8. Rearden Metals expects to have earnings this coming year of $2.50 per share. Rearden plans to retain all of its earnings for the next year. For the subsequent three years, the firm will retain

50% of its earnings. It will then retain 25% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 20% per year. Any earnings that are not retained will be paid out as dividends. Assume Rearden's shares outstanding remains constant and all earnings growth comes from the investment of retained earnings. If Rearden's equity cost of capital is 10%, then Rearden's stock price is closest to: A) $40.80 B) $44.60 C) $59.80 D) $63.50 Answer: B

Year 1 2 3 4 5

EPS $2.50 $3.00 $3.30 $3.63 $3.99

Growth in Earnings Retained (.20 × Earnings R.E.) Dividends $2.50 $0.50 0 $1.50 $0.30 $1.50 $1.65 $0.33 $1.65 $1.82 $0.36 $1.82 $1.00 $0.20 $2.99

growthyear 5 = P0 =

+

= .050125 or 5% +

+

= 44.57

9. A higher retention ratio will most likely result in a higher: A. Dividend payout ratio. B. Return on equity. C. Growth rate.

10. For most firms, P/E ratios and risk A. will be directly related. B. will have an inverse relationship. C. will be unrelated. D. will both increase as inflation increases. E. None of these is correct.

11. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. Calculate the projected free cash flow of Utica Manufacturing Company for the coming year. Complete solution has to be provided to get full credit. (4 marks)

Calculations are shown below.

12. The growth in per share FCFE of FOX, Inc. is expected to be 15%/year for the next three years, followed by a growth rate of 8%/year for two years; after this five year period, the growth in per share FCFE is expected to be 3%/year, indefinitely. The required rate of return on FOX, Inc. is 13%. Last year's per share FCFE was $1.85. What should the stock sell for today? Complete solution has to be provided to get full credit. (6 marks) Calculations are shown below

P5 = 3.28 (1.03)/(.13 − .03) = $33.80; PV of P5 = $33.80/(1.13)5 = $18.35; PO = $18.35 + $9.39 = $27.74.

13. Define the following terms: (a) PVGO Refer to course pack for definition (b) PEG ratio Refer to course pack for definition

(c) Earnings management

Refer to course pack for definition

(d) Earnings yield Refer to course pack for definition

(e) Two-stage DDM Refer to course pack for definition

(5 marks)