FIN3403 Ch7 8 Practice Questions 1 Given the risk of XYZ corp common stock your required rate of return is 16 Given the current economic conditions and the current market price of the stock you determine that the stock s expected return for the upcoming year is 14 Which of the following is true a the stock is overpriced b the stock is underpriced c the stock is correctly priced d the stock price should rise e both b and d are correct Answer A the stock is overpriced because the required rate the expected rate 2 Medical Supply Company has a beta of 1 55 and recently paid a common stock dividend of 3 47 If the return on Treasury securities is currently 7 5 and the return on the S P 500 index is 12 what is the required rate of return on the common stock Use CAPM equation Kj Kc Km Kf Kj required rate of return Kc risk free rate Km market rate beta Kj 7 5 1 55 12 7 5 Answer 14 475 3 Dimensions Corporation s preferred stock recently paid its annual dividend of 6 75 per share The par value of the preferred stock is 100 Investors require a 9 rate of return on this stock What is the intrinsic value of the preferred stock Vps D Kps Vps Value of preferred stock D dividend Kps rate of return Vps 6 75 0 09 Answer 75 4 Food Chain Inc common stock recently paid a dividend of 2 60 The firm typically pays out 50 of its earnings as dividends and retains the rest for investment in the firm Food chain has a return on equity of 15 If investors require a return of 12 what is the intrinsic value of the firm s common stock Assume dividends will grow at a constant rate Vcs D Kcs g Vcs value of common stock D D 1 g g growth rate ROE ret rate ret rate 1 pay out g 0 15 x 1 0 5 7 5 D 2 6 1 0 075 2 795 Vcs 2 795 0 12 0 15 62 11 Answer 62 11 5 Hampton Corporation s common stock dividends are expected to grow by 8 per year Recently the firm paid a 3 00 common stock dividend Hampton has a beta of 1 40 The expected return on the S P 500 index is 12 5 and the rate of return on U S treasury securities is 7 Using this information what is the stock s intrinsic value Vcs D Kcs g Vcs value of common stock Kcs Kc Km Kf Kc risk free rate 7 Km market rate 12 5 Kf risk free rate 7 Kcs 7 1 4 12 5 7 14 7 Kcs 14 7 D D 1 g D 3 1 0 08 D 3 24 Vcs 3 24 14 7 0 08 Vcs 48 36 Answer 48 36 6 TPI company common stock is currently selling for 80 Industry analysts are forecasting a dividend of 4 60 for next year and a growth rate of 8 per year for the foreseeable future What is the expected annual rate of return for the stock Kcs D P g Kcs expected annual rate D D 1 g P market price 80 g growth rate 0 08 Anytime the dividend has not been paid yet or not recently is D If it has recently been paid then it is D Kcs 4 6 80 0 08 Answer 13 75 7 In one year Hitech Microdevices will pay a common stock dividend of 4 35 You predict that you will be able to sell your Hitech stock for 57 per share after 1 year If you require a rate of return of 16 on Hitech stock how much would you be willing to pay now for a share of the stock Vcs D 1 Kcs P 1 Kcs D 4 35 Kcs 0 016 P 57 Kcs 0 016 Answer 52 89 8 Rosen Fashions common stock recently paid a dividend of 2 75 Investors require a 18 rate of return on this stock Rosen earns a 30 return on equity The firm pays 55 of its earnings as dividends and reinvests 45 of earnings in the firm What is the value of the stock Vcs D Kcs g g ROE x ret rate 0 3 0 45 0 135 D D 1 g 2 75 1 0 135 3 12 Kcs 0 18 Answer 69 9 Clayton Corporation common stock is expected to pay a dividend of 2 95 in one year Company earnings and dividends are expected to grow at an annual rate of 9 If you can buy this stock for 34 71 what is your expected return Kcs D P g D 2 95 P 34 71 g 0 09 Answer 17 5 10 You expect Technomess Company common stock to pay a dividend of 2 40 one year from now You can buy the stock now for 52 and you plan to sell the stock at the end of one year Given the risk of the stock your required rate of return is 16 For what price would you need to sell your stock in one year in order to earn your required rate of return Vcs D 1 Kcs P 1 Kcs D 2 40 P 52 Kcs 0 16 Answer 58 11 You are interested in buying 100 shares of Diversified Company s 60 par value preferred stock The stock has a dividend rate of 8 5 If your required return is 11 how much would you be willing to pay to acquire the 100 shares Vps D Kps x 100 D 0 085 60 5 10 Kps 0 11 Answer 4 636 12 Warp O Corporation common stock has a market price of 45 per share Warp O has a beta of 1 4 The rate of return on Treasury bonds is currently 6 and the return on the S P 500 is 13 What is the required rate of return on Warp O common stock CAPM Kcs Kf Km Krf Beta 1 4 Kf risk free rate 6 Km market rate 13 Kcs 6 1 4 13 6 Answer 15 8