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# Stock's & Bond's Valuation; Time Value of Money

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Financial Management Problems

26. You need to accumulate \$10,000. To do so, you plan to make a deposit of \$1,250 per year - with the first payment being made a year from today - into a bank account that pays 12% annual interest. Your last deposit will be less than \$1,250 if less is needed to round out to \$10,000. How many years will t take you to reach your \$10,000 goal, and how large will the last deposit be?

1. Define each of the following terms:

a) Proxy; proxy fight; pre-emptive right; classified stock; founder's shares
b) Estimated value (Po); market price (Po)
c) Required rate of return, rs; expected rate of return, rs; actual, or realized, rate of return, rs
d) Capital gains yield; dividend yield; expected total return
e) Constant growth; no constant growth; zero growth stock
f) Preferred stock
g) Nonoperation assets
h) Value of operations; horizon value; free cash flow valuation model

2. Constant Growth Valuation:

Boehm Incorporated is expected to pay a \$1.50 per share dividend at the end of this year. The dividend is expected to grow at a constant rate of 6% a year. The required rate of return on the stock is 13%. What is the estimated value per share of Boehm's stock?

5. No constant Growth Valuation

A company currently pays a dividend of \$2 per share. It is estimated that the
company's dividend will grow at a rate of 20% per year for the next 2 years, and 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 stocks?
Current price?

#### Solution Summary

A guide for several financial management problems

\$2.19

## Time Value of Money, Valuation, and Rates of Return

Time Value of Money, Valuation, and Rates of Return

1. The concept of compound interest refers to:
A)earning interest on the original investment.
B)payment of interest on previously earned interest.
C)investing for a multi-year period of time.
D)determining the APR of the investment.

2. When an investment pays only simple interest, this means:
A)the interest rate is lower than on comparable investments.
B)the future value of the investment will be low.
C)the earned interest is non taxable to the investor.
D)interest is earned only on the original investment.

3. Assume the total expense for your current year in college equals \$20,000. Approximately how much would your parents have needed to invest 21 years ago in an account paying 8% compounded annually to cover this amount?
A)\$ 952
B)\$1,600
C)\$1,728
D)\$3,973

4. How much will accumulate in an account with an initial deposit of \$100, and which earns 10% interest compounded quarterly for three years?
A)\$107.69
B)\$133.10
C)\$134.49
D)\$313.84

5. How much must be invested today in order to generate a five-year annuity of \$1,000 per year, with the first payment one year from today, at an interest rate of 12%?
A)\$3,604,78
B)\$3,746.25
C)\$4,037.35
D)\$4,604.78

6. What is the rate of return for an investor who pays \$1,054.47 for a three-year bond with a 7% coupon and sells the bond one year later for \$1,037.19?
A)5.00%
B)5.33%
C)6.46%
D)7.00%

7. What price would you expect to pay for a stock with 13% required rate of return, 4% rate of dividend growth, and an annual dividend of \$2.50 which will be paid tomorrow?
A)\$27.78
B)\$30.28
C)\$31.10
D)\$31.39

8. What is the required return for a stock that has a 5% constant growth rate, a price of \$25, an expected dividend of \$2, and a P/E ratio of 10?
A)5%
B)10%
C)13%
D)22%

Capital Structure and Long-Term Financing Strategies

9. A stock's par value is represented by:
A)the maturity value of the stock.
B)the price at which each share is recorded.
C)the price at which an investor could sell the stock.
D)the price received by the firm when the stock was issued.

10. Additional paid-in capital refers to:
A)a firm's retained earnings.
B)a firm's treasury stock.
C)the difference between the issue price and the par value.
D)funds borrowed from a bank or bondholders.

11. Which of the following equity concepts would you expect to be least important to a financial analyst?
A)Par value per share
C)Retained earnings
D)Net common equity

12. An increase in a firm's financial leverage will:
A)increase the variability in earnings per share.
B)reduce the operating risk of the firm.
C)increase the value of the firm in a non-MM world.
D)increase the WACC.

13. Financial risk refers to the:
A)risk of owning equity securities.
B)risk faced by equityholders when debt is used.
C)general business risk of the firm.
D)possibility that interest rates will increase.

14. Ignoring taxes, a firm's weighted-average cost of capital is equal to:
A)its expected return on assets.
B)its expected return on equity.
C)the sum of expected return on equity and expected return on debt.
D)its expected return on assets times the debt-equity ratio.

15. What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.
A)54.0%
B)60.0%
C)66.7%
D)75.0%

16. A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%. What debt-equity ratio should be used in order to keep the WACC at 12%?
A).50
B).75
C)1.00
D)1.50

17. Which of the following is not found in John Lintner's "stylized facts" of corporate dividend policies?
A)Firms have long-run target dividend payout ratios.
B)Managers focus more on dividend absolute levels than on its changes.
C)Dividend changes follow shifts in long-run, sustainable levels of earnings rather than short-run changes in earnings.
D)Managers are reluctant to make dividend changes that might have to be reversed.

18. An increase in dividends might not increase price and may actually decrease stock price if:
A)the dividend increase cannot be sustained.
B)the firm does not maintain an exact dividend payout ratio.
C)the firm has too much retained earnings.
D)markets are weak-form efficient.

19. A policy of dividend "smoothing" refers to:
A)maintaining a constant dividend payout ratio.
B)keeping the regular dividend at the same level indefinitely.
C)maintaining a steady progression of dividend increases over time.
D)alternating cash dividends with stock dividends.

20. What is the most likely prediction after a firm reduces its regular dividend payment?
A)Earnings are expected to decline.
B)Investment is expected to increase.
C)Retained earnings are expected to decrease.
D)Share price is expected to increase.

21. Under the idealized conditions of MM, which statement is correct when a firm issues new stock in order to pay a cash dividend on existing shares?
A)The new shares are worth less than the old shares.
B)The old shares drop in value to equal the new price.
C)The value of the firm is reduced by the amount of the dividend.
D)The value of the firm is unaffected.

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