A stock pays annual dividends. It just paid a dividend of $4. The growth rate in the dividend is 2% pa. You estimate that the stock's required return is 8% pa. Both the discount rate and growth rate are given as effective annual rates.

Which of the following statements is NOT correct?

a.

The dividend at time t=3 will be $4.1616

b.

The long-term capital return of the stock is 2%

c.

The share price at time t=0 is $68.00

d.

Total return of the stock is equal to the company's long term cost of equity.

e.

Total return of the stock is equal to the dividend yield plus the capital return.

ou discover an investment costing $3,000 which has an expected total return of 15% pa, but a required return of only 11% pa. Of the 15% pa total expected return, the capital return is expected to be 8% pa. Assume that the required return of 11% remains constant, the dividends can only be re-invested at 11% pa and all returns are given as effective annual rates.

Which of the following statements is NOT correct?

a.

The expected dividend return is 7%

b.

The investment is currently under-priced

c.

You would use a discount rate of 11% to find the NPV of this investment

d.

The investments price at time t=20 would be $49,099.61

e.

When plotted on the Security Market Line, the investment would have a positive alpha.

Use the following information to value a firms assets.

Assume the following:

• the market value of the firm's assets is expected to remain constant over time so the firm doesn't grow and can be valued as a level perpetuity,
• the firm has a constant debt-to-assets ratio,
• the bonds are priced at par, and
• the stock's expected capital returns are zero.

Relevant data:

• The number of shares on issue is 2 million and the number of bonds is 1 million
• The constant annual dividend per share is $5
• The bonds have an annual fixed coupon payment of $4
• 10-year government bonds have a yield of 3% and the market risk premium is 5%
• The beta of levered equity is 1.6
• The beta of the bonds is 1.3

Which of the following is the market value of the levered firms assets?

a.

$112.6 million

b.

$140.9 million

c.

$93.2 million

d.

$102.4 million

e.

$133.0 million

Which statement about capital structure is the most correct?

a.

A company in a risky industry with volatile cash flows will usually choose to take less debt than a company in a stable industry.

b.

The more the company borrows, the lower will be the after-tax WACC. This increases the present value of the firm free cash flows which represents the value of the levered firm. Therefore, a firm should always seek to borrow as much debt as possible.

c.

Because the cost of debt is cheaper than the cost of equity, a company should use as much debt as possible to finance their projects

d.

The more the company borrows, the higher will be its tax shields, therefore a company will always prefer to issue debt than equity.

e.

Lenders rank ahead of shareholders when the company goes bankrupt. This increased risk for shareholders means the cost of equity is lower than the cost of debt.