CHAPTER 7 STOCK AND EQUITY MARKET
1. The stock valuation model that determines the current stock price as the next dividend divided by
the (discount rate less the dividend growth rate) is called the:
A) Zero growth model.
B) Dividend growth model.
C) Capital Asset Pricing Model.
D) Earnings capitalization model.
Answer: B
2. A stock's next expected dividend divided by the current stock price is the:
A) Current yield.
B) Total yield.
C) Dividend yield.
D) Capital gains yield.
E) Earnings yield.
Answer: C
3. The rate at which the stock price is expected to appreciate (or depreciate) is the:
A) Current yield.
B) Total yield.
C) Dividend yield.
D) Capital gains yield.
E) Earnings yield.
Answer: D
4. Payments made by a corporation to its shareholders, in the form of either cash, stock, or payments
in kind, are called:
A) Retained earnings.
B) Net income.
C) Dividends.
D) Redistributions.
E) Infused equity.
Answer: C
5. The market in which new securities are originally sold to investors is the ________ market.

A) dealer
B) auction
C) over-the-counter (OTC)
D) secondary
E) primary
Answer: E
6. The market in which previously issued securities are traded among investors is the:
A) Dealer market.
B) Auction market.
C) Over-the-counter (OTC) market.
D) Secondary market.
E) Primary market.
Answer: D


7. Common stock valuation requires, among other things, information regarding the:
I. Expected dividend growth rate.
II. Current dividend payment.
III. Par value of the common stock.
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III
Answer: B
8. As illustrated using the dividend growth model, the total return on a share of common stock is
comprised of a ___________.
A) capital gains yield and a dividend growth rate
B) capital gains growth rate and a dividend growth rate
C) dividend payout ratio and a required rate of return

D) dividend yield and the present dividend
E) dividend yield and a capital gains yield
Answer: E
9. Which of the following items would usually appear for a stock quote in The Wall Street Journal?
A) Capital gains rate
B) Dividend yield
C) Number of shares outstanding
D) Par value of the stock
E) Dividend growth rate
Answer: B
10. If dividends on a common stock are expected to grow at a constant rate forever, and if you are
told the most recent dividend paid, the dividend growth rate, and the appropriate discount rate
today, you can calculate ___________.
I. the price of the stock today
II. the dividend that is expected to be paid ten years from now
III. the appropriate discount rate ten years from now
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III
Answer: B
11. Which of the following statements regarding dividend yields is true?
A) It measures how much the stock's price will increase in a year.
B) It incorporates the par value of the stock into the calculation.
C) It is analogous to the current yield for a bond.
D) It is always greater than the stock's capital gains yield.
E) It measures the total annual return an investor can expect to earn by owning the stock.
Answer: C
12. Which of the following is (are) true?

I. The dividend yield on a stock is the annual dividend divided by the par value.


II. When the constant dividend growth model holds, g = capital gains yield.
III. The total return on a share of stock = dividend yield + capital gains yield.
A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III
Answer: D
13. If some shareholders have greater voting power than others, it must be that:
A) The company has both preferred stock and common stock outstanding.
B) The company has outstanding debentures.
C) The company is located outside the United States in a tax-haven locale.
D) The company has multiple classes of common stock.
E) The company is in bankruptcy proceedings.
Answer: D
14. What would you pay for a share of ABC Corporation stock today if the next dividend will be $3
per share, your required return on equity investments is 15%, and the stock is expected to be
worth $90 one year from now?
A) $78.26
B) $80.87
C) $82.56
D) $90.00
E) $98.12
Answer: B
Response: P0 = $3 / 1.15 + 90 / 1.15 = $80.87
15. The dividend on Simple Motors common stock will be $3 in 1 year, $4.25 in 2 years, and $6.00 in
3 years. You can sell the stock for $100 in 3 years. If you require a 12% return on your

investment, how much would you be willing to pay for a share of this stock today?
A) $75.45
B) $77.24
C) $81.52
D) $85.66
E) $91.30
Answer: C
Response: P0 = $3.00 / 1.12 + 4.25 / 1.122 + 106 / 1.123 = $81.52
Or use your CF keystrokes: Thusly: CF0, 2nd, CLR WORK, CF0, 0, Enter, ↓, CO1, 3, Enter, ↓,
FO1, 1, Enter, ↓, CO2, 4.25, Enter, ↓, FO2, 1, Enter, ↓, CO3, 106, Enter, ↓, FO3, 1, Enter, ↓,
CO4, NPV, I, 12, Enter, ↓, NPV, CPT, NPV = 81.52
16. A stock that pays a constant dividend of $1.50 forever currently sells for $10.71. What is the
required rate of return?
A) 10%
B) 12%
C) 13%
D) 14%
E) 15%
Answer: D
Response: $10.71 = $1.50 / R; R = 14%



17. ABC Company's preferred stock is selling for $30 a share. If the required return is 8%, what will
the dividend be two years from now?
A) $2.00
B) $2.20
C) $2.40
D) $2.80
E) $3.25

Answer: C
Response: $30 = D / .08; D = $2.40
18. What would you pay today for a stock that is expected to make a $2 dividend in one year if the
expected dividend growth rate is 5% and you require a 12% return on your investment?
A) $28.57
B) $29.33
C) $31.43
D) $43.14
E) $54.30
Answer: A
Response: P0 = $2 / (.12 - .05) = $28.57
19. The stock of MTY Golf World currently sells for $90 per share. The firm has a constant dividend
growth rate of 6% and just paid a dividend of $5.09. If the required rate of return is 12%, what
will the stock sell for one year from now?
A) $ 90.00
B) $ 93.52
C) $ 95.40
D) $ 99.80
E) $112.78
Answer: C
Response: P1 = P0(1 + g) = $90 (1.06) = $95.40
20. Llano's stock is currently selling for $40.00. The expected dividend one year from now is $2 and
the required return is 13%. What is this firm's dividend growth rate assuming the constant
dividend growth model is appropriate?
A) 8%
B) 9%
C) 10%
D) 11%
Answer: A
Response: g = .13 - ($2 / 40) = 8%

21. The current price of XYZ stock is $80.00. Dividends are expected to grow at 5% indefinitely and
the most recent dividend was $2.75. What is the required rate of return on XYZ stock?
A) 7.3%
B) 8.7%
C) 9.5%
D) 10.6%
E) 11.2%
Answer: B
R = D1/Po + g = Do(1+g)/Po + g = [2.75(1.05)]/80 + .05
Response: R = ($2.89 / 80) + .05 = 8.7%


22. ABC Corporation's common stock dividend yield is 3.61%, it just paid a dividend of $2.75, and is
expected to pay a dividend of $2.89 one year from now. Dividends are expected to grow at a
constant rate indefinitely. What is the required rate of return on ABC stock?
A) 7.3%
B) 8.7%
C) 9.5%
D) 10.6%
E) 11.2%
Answer: B
Response: ($2.89 - 2.75) / 2.75 = .051; R = .036 + .051 = 8.7%
23. If Big Amp, Inc. stock closed at $36 and the current quarterly dividend is $0.75 per share, what
dividend yield would be reported for the stock in The Wall Street Journal?
A) 2.0%
B) 3.6%
C) 5.7%
D) 6.6%
E) 8.3%
Answer: E

Response: DY = ($0.75 x 4) / 36 = 8.3%
24. Suppose NoGro, Inc. has just issued a dividend of $3.25 per share. Subsequent dividends will
remain at $3.25 indefinitely. Returns on the stock of firms like NoGro are currently running 10%.
What is the value of one share of stock?
A) $22.50
B) $27.25
C) $32.50
D) $37.25
E) $39.75
Answer: C
Response: P0 = $3.25 / .10 = $32.50
25. Suppose Pale Hose, Inc. has just paid a dividend of $1.80 per share. Sales and profits for Pale
Hose are expected to grow at a rate of 8% per year. Its dividend is expected to grow by the same
amount. If the required return is 14%, what is the value of a share of Pale Hose?
A) $18.00
B) $25.20
C) $27.80
D) $30.60
E) $32.40
Answer: E
Response: P0 = [$1.80(1.08)] / (.14 - .08) = $32.40
26. Suppose that you have just purchased a share of stock for $40. The most recent dividend was $2
and dividends are expected to grow at a rate of 7% indefinitely. What must your required return
be on the stock?
A) 5.45%
B) 7.00%
C) 10.25%
D) 12.35%



E) 13.65%
Answer: D
Response: R = [$2(1.07)] / 40 + .07 = 12.35%


27. The preferred stock of the Limbaugh Institute pays a constant annual dividend of $4 and sells for
$50. You believe the stock will sell for $32 in one year. You must, therefore, believe that the
required return on the stock will be _____ percentage points ________ in one year.
A) 8; higher
B) 8; lower
C) 1.5; higher
D) 2.5; lower
E) 4.5; higher
Answer: E
Response: current yield is just 4/50 or .08 or R = 8%; next year? The yield will be 4/32 or 12.5%
The yield in one year is 4.5% lower. (.08 - .125 = -.045)
28. A firm's stock has a required return of 12%. The stock's dividend yield is 5%. What is the
dividend the firm is expected to pay in one year if the current stock price is $50?
A) $2.00
B) $2.50
C) $3.00
D) $3.50
E) $4.00
Answer: B
Response: D1 = $50 (.05) = $2.50
29. A firm's stock has a required return of 12%. The stock's dividend yield is 5%. What dividend did
the firm just pay if the current stock price is $50?
A) $2.18
B) $2.34
C) $2.50

D) $2.87
E) $3.60
Answer: B
Response: D0=D1/(1 + g); R = D1/P0 + g. .12 = .05 + g … g must be .07. D1 = P0(Dividend Yld)
D1 = 50(.05) = 2.50. The most recent dividend equals the next dividend backed up one period, or
the next dividend divided by (1 + g)… or….D0=2.50/(1 + .07) = 2.5/1.07 = 2.34
Use the following to answer questions 30-36:
52 Weeks
Hi
Lo
48.72
20.10

Stock
Duke Energy

Sym
DUK

Div
1.00

Yld
%
3.3

PE
18

Vol

100s
20925

Hi
31.55

Lo
29.40

Close
30.20

30. Duke stock must have closed at ___________ per share on the previous trading day.
A) $29.64
B) $30.76
C) $30.99
D) $31.55
E) $32.11
Answer: B
Response: 30.76 - 0.56 = 30.20
31. For the current year, the expected dividend per share is:
A) $0.25

Chg.
–.56


B) $1.00
C) $2.00
D) $3.30

E) $4.00
Answer: B
Doing the algebra? Expected DPS = Yld x Close = .033 x 30.20 = 1
32. Assume the expected growth rate in dividends is 10%. Then the constant growth model suggests
that the required return on Duke stock is:
A) 7.4%
B) 8.9%
C) 11.0%
D) 13.6%
E) 15.8%
Answer: D
Response: R = [($1.00 x 1.10) / 30.20] + .10 = 13.6%
33. Based on the quote, a good estimate of EPS over the last four quarters is:
A) $0.80
B) $1.21
C) $1.68
D) $1.91
E) $2.54
Answer: C
Response: EPS = $30.20 / 18 = $1.68
34. On this trading day, the number of Duke shares which changed hands was:
A) 209
B) 2,092
C) 20,925
D) 209,250
E) 2,092,500
Answer: E
The algebra? How about 20,925 x 100 = 2,092,500
35. Assume that Duke paid a $0.92 annual dividend in the previous period. What is the dividend
growth rate based on this quote?

A) 4.8%
B) 6.0%
C) 7.2%
D) 8.7%
E) 9.9%
Answer: D : Response: g = ($1.00 / 0.92) - 1 = 8.7%
36. You believe that the required return on Duke stock is 16% and that the expected dividend growth
rate is 12%, which is expected to remain constant for the foreseeable future. Is the stock currently
overvalued, undervalued, or fairly priced?
A) Overvalued
B) Undervalued
C) Fairly priced


D) Cannot tell without more information
Answer: A
Response: P0 = [$1.00 (1.12) ] / (.16 - .12) = $28.00; overvalued at $30.20 in the market