Stock Valuation – Practice Questions

(7–1)
DPS Calculation
Three Industries just paid a dividend of $1.50 a share (i.e., D0 = $1.50). The dividend is expected to grow 5% a year for
the next 3 years and then 10% a year thereafter. What is the expected dividend per share for each of the next 5 years?
(7–2)
Constant Growth
Valuation
Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (i.e., D1 = $1.50). The dividend
is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the
value per share of Boehm’s stock?
(7–3)
Constant Growth
Valuation
Woidtke Manufacturing’s stock currently sells for $20 a share. The stock just paid a dividend of $1.00 a share (i.e., D0
= $1.00), and the dividend is expected to grow forever at a constant rate of 10% a year. What stock price is expected
1 year from now? What is the required rate of return on Woidtke’s stock?
(7–4)
Preferred Stock
Valuation
Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The
preferred sells for $50 a share. What is the stock’s required rate of return?
(7–5)
Non-constant Growth
Valuation
A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow
at a rate of 20% per year for the next 2 years, then at a constant rate of 7% thereafter. The company’s stock has a beta
of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?
(7–6)
Constant Growth
Rate, g
A stock is trading at $80 per share. The stock is expected to have a year-end dividend of $4 per share (D1 = $4), and it
is expected to grow at some constant rate g throughout time. The stock’s required rate of return is 14%. If markets
are efficient, what is your forecast of g?
(7–7)
Constant Growth
Valuation
You are considering an investment in Crisp Cookware’s common stock. The stock is expected to pay a dividend of $2 a
share at the end of this year (D1 = $2.00); its beta is 0.9; the risk-free rate is 5.6%; and the market risk premium is 6%.
The dividend is expected to grow at some constant rate g, and the stock currently sells for $25 a share. Assuming the
market is in equilibrium, what does the market believe will be the stock’s price at the end of 3 years (i.e., what is ^P3)?
(7–8)
Preferred Stock
Rate of Return
What is the nominal rate of return on a preferred stock with a $100 par value, a stated dividend of 8% of par, and a
current market price of (a) $60, (b) $80, (c) $100, and (d) $140?
(7–9)
Declining Growth
Stock Valuation
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 = $5 and rs = 15%, what is the value of Brushy Mountain’s stock?

1
Stock Valuation – Practice Questions

(7–10)
Rates of Return and
Equilibrium
The beta coefficient for Stock C is bC = 0.4 and that for Stock D is bD = −0.5. (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 9% and the expected rate of return on an average stock is 13%, what are the required rates of
return on Stocks C and D?
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 were not
in equilibrium.
(7–11)
Non-constant Growth
Stock Valuation
Assume that the average firm in your company’s industry is expected to grow at a constant rate of 6% and that its
dividend yield is 7%. Your company is about as risky as the average firm in the industry, but it has just successfully
completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 =
D0(1 + g) = D0(1.50)] this year and 25% the following year, after which growth should return to the 6% industry
average. If the last dividend paid (D0) was $1, what is the value per share of your firm’s stock?
(7–12)
Non-constant Growth
Stock Valuation
Simpkins Corporation is expanding rapidly, and it does not pay any dividends because it currently needs to retain all
of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $1.00 coming
3 years from today. The dividend should grow rapidly—at a rate of 50% per year—during Years 4 and 5. After Year 5,
the company should grow at a constant rate of 8% per year. If the required return on the stock is 15%, what is the
value of the stock today?
(7–13)
Preferred Stock
Valuation
Several years ago, Rolen Riders issued preferred stock with a stated annual dividend of 10% of its $100 par value.
Preferred stock of this type currently yields 8%. Assume dividends are paid annually.
a. What is the value of Rolen’s preferred stock?
b. Suppose interest rate levels have risen to the point where the preferred stock now yields 12%. What would be the
new value of Rolen’s preferred stock?
(7–14)
Return on Common
Stock
You buy a share of The Ludwig Corporation stock for $21.40. You expect it to pay dividends of $1.07, $1.1449, and
$1.2250 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $26.22 at the end of 3 years.
a. Calculate the growth rate in dividends.
b. Calculate the expected dividend yield.
c. Assuming that the calculated growth rate is expected to continue, you can add the dividend yield to the expected
growth rate to obtain the expected total rate of return. What is this stock’s expected total rate of return?
(7–15)
Constant Growth Stock
Valuation
Investors require a 15% rate of return on Brooks Sisters’s stock (rs = 15%).
a. What would the value of Brooks’s stock be if the previous dividend was D0 = $2 and if investors expect dividends to
grow at a constant annual rate of (1) −5%, (2) 0%, (3) 5%, and (4) 10%?
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) 20%? Are these reasonable results? Explain.
c. Is it reasonable to expect that a constant growth stock would have g > rs?