Chapter 8 Finance
CHAPTER 8
STOCKS AND THEIR VALUATION (Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Required return Answer: e Diff: E
[i]. An increase in a firm’s expected growth rate would normally cause the firm’s required rate of return to
a. Increase. b. Decrease. c. Fluctuate. d. Remain constant. e. Possibly increase, possibly decrease, or possibly remain unchanged.
Required return Answer: d Diff: E
[ii]. If the expected rate of return on a stock exceeds the required rate,
a. The stock is experiencing supernormal growth. b. The stock should be sold. c. The company is probably not trying to maximize price per share. d. The stock is a good buy. e. Dividends are not being declared.
Required return Answer: a Diff: E
[iii]. 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. d. Statements a and c are correct. e. All of the statements above are correct.
Constant growth model Answer: a Diff: E
[iv]. Which of the following statements is most correct?
a. The constant growth model takes into consideration the capital gains earned on a stock. b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes constant. c. Two firms with the same dividend and growth rate must also have
STOCKS AND THEIR VALUATION (Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Required return Answer: e Diff: E
[i]. An increase in a firm’s expected growth rate would normally cause the firm’s required rate of return to
a. Increase. b. Decrease. c. Fluctuate. d. Remain constant. e. Possibly increase, possibly decrease, or possibly remain unchanged.
Required return Answer: d Diff: E
[ii]. If the expected rate of return on a stock exceeds the required rate,
a. The stock is experiencing supernormal growth. b. The stock should be sold. c. The company is probably not trying to maximize price per share. d. The stock is a good buy. e. Dividends are not being declared.
Required return Answer: a Diff: E
[iii]. 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. d. Statements a and c are correct. e. All of the statements above are correct.
Constant growth model Answer: a Diff: E
[iv]. Which of the following statements is most correct?
a. The constant growth model takes into consideration the capital gains earned on a stock. b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes constant. c. Two firms with the same dividend and growth rate must also have