CFA Level 2 - Equity Session 11 - Reading 42 Discounted Dividend Valuation - LOS c

CFA Level 2 – Equity, Session 11-Reading 42

Discounted Dividend Valuation – LOS c

(Practice Questions, Sample Questions)

1. The value per share for Burton, Inc. is $32.00 using the Gordon Growth model. The company paid a dividend of $2.00 last year. The estimates used to calculate the value have changed. If the new required rate of return is 12.00% and expected growth rate in dividends is 6%, the value per share will increase by:

A) 4.17%.

B) 9.51%.

C) 42%.

[Explanation: (C) The value per share using the new estimates is $35.33 = [$2.0(1.06) / 0.12 – 0.06)] and the percentage increase in the value per share will be 10.

42% = [(35.33 – 32.00) / 32.00] × 100%]

2. Suppose the equity required rate of return is 10%, the dividend just paid is $1.00 and dividends are expected to grow at an annual rate of 6% forever. What is the expected price at the end of year 2?

A) $28.09.

B) $27.07.

C) $29.78

[Explanation: (C) The terminal value is $29.78, and that is the price an investor should be willing to pay at the end of year 2. The correct answer is shown below.

Year

Dividend

1

$1.0600

2

$1.1236

3

$1.1910

V3:$1.191/(0.10 – 0.06) = $29.78]

3. A company reports January 1, 2002, retained earnings of $8,000,000, December 31, 2002, retained earnings of $10,000,000, and 2002 net income of $5,000,000. The company has 1,000,000 shares outstanding and dividends are expected to grow at a rate of 5% per year. What is the expected dividend at the end of 2003?

A) $3.00.

B) $3.15.

C) $13.65.

[Explanation: (B) The first step is to determine 2002 dividends paid as ($8,000,000 + $5,000,000 ? 10,000,000) = $3,000,000. The next step is to find the dividend per share ($3,000,000 / 1,000,000 shares) = $3.00 per share. Applying the 5% growth rate, next year’s expected dividend is $3.15, or $3.00 × 1.05.]

4. Jax, Inc., pays a current dividend of dividend of $0..

   Get quality help now

   

   Prof. Finch

   Verified

   Proficient in: Economics

   4.7 (346)

   “ This writer never make an mistake for me always deliver long before due date. Am telling you man this writer is absolutely the best. ”

   

   +84 relevant experts are online

   Hire writer

   52 and is projected to grow at 12%. If the required rate of return is 11%, what is the current value based on the Gordon growth model?

A) unable to determine value using Gordon model.

B) $58.24.

C) $39.47.

[Explanation: (A) The Gordon growth model cannot be used if the growth rate exceeds the required rate of return.]

5. A firm currently pays a dividend of $1.77, which is expected to grow at a rate of 4%. If the required return is 10%, what is the current value of the shares using the Gordon growth model?

A) $29.76.

B) $29.50.

C) $30.68.

[Explanation: (C) The current value of the shares is $30.68:

V0 = [$1.77(1 + 0.04)] / (0.10 – 0.04)] = $30.68.]

6. Jand, Inc., currently pays a dividend of $1.22, which is expected to grow at 5%. If the current value of Jand’s shares based on the Gordon model is $32.03, what is the required rate of return?

A) 8%.

B) 9%.

C) 7%.

[Explanation: (B) The required return is 9%: r = [$1.22(1 + 0.05) / $32.03] + 0.05 = 0.09 or 9%]

7. A firm’s dividend per share in the most recent year is $4 and is expected to grow at 6% per year forever. If its shareholders require a return of 14%, the value of the firm’s stock (per share) using the single-stage dividend discount model (DDM) is:

A) $53.00.

B) $50.00.

C) $28.57.

[Explanation: (A) The value of the firm’s stock is: $4 × [1.06 / (0.14 ? 0.06)] = $53.00]