Part I. (5 questions; 1 or 2 points each; True/False Questions) Decide whether each of the following statements is true or false. If false, change the incorrect parts to make them true. DO NOT NEGATE THE FALSE SENTENCES.

1. The higher the ROE, the higher the market capitalization rate.

2. When an increase in the inflation growth is expected, the required rate of return would generally decrease.

3. Stock prices reflect past earnings, dividends, and interest rates.

4. The cyclical indicator approach covers all important major economic sectors including the service sector and import-exports.

5. According to the weak-form efficient market hypothesis, investors can take advantage of historical information.

Part II. (10 questions; 1 point per blank; Short Answers) Choose the answers that best complete the following sentences.

6. By _________ government bonds, the Federal Reserve absorbs excess liquidity from the market.

7. If the Federal Reserve pursues a contractionary monetary policy, interest rates will ________ and inflation will ________.

8. ____________________ are composed of economic indices that usually reach peaks or troughs after the corresponding movements in economic activities.

9. ________ industries will most likely excel when the economy is at the peak; but when the economy is at the trough _______ industries will most likely be the best choice for investment.

10. The difference between the interest rate and the inflation rate reflects the ___________ return.

11. If interest rates _______ due to an increase in inflation and corporate earnings _______, stock prices will likely decrease.

12. Based on the constant growth dividend discount model, PE ratio tends to be lower if inflation is _______, because inflation affects __________ to become higher.

13. According to the efficient market hypothesis, stock prices follow a _________ walk, and stock prices will adjust _________ when new information arrives.

14. One of the most widely used expansionary fiscal policy tools is ________ budget deficits.

15. The relationship between required rate of return and expected rate of return would be similar to that between plowback ratio and ________ ratio.

Part III. (3 Questions; 55 points) Please show all your work and the answers to receive credit. If you do not show your work, you will NOT obtain full credit regardless of your answer.

16. (10 pts) Toddler Inc. has reported ROE of 7.5% and a dividend payout ratio of 50%. Its expected dividend payout for the next year is $1.2 per share, and the market capitalization rate is 9.55%. Assume the constant growth DDM.

(a) (2 pts) What is the dividend growth rate of Toddler?

(b) (4 pts) What is Toddler's intrinsic value for today (t0)?

(c) (4 pts) What is Toddler's intrinsic value if measured three years from today (t3)?

17. (10 pts) Flyers, Inc., just paid an EPS of $6.6 this year. Flyers is expected to maintain a retained earnings ratio of 60% and ROE of 6.8% for the next five years. After the fifth year, ROE is expected to decrease to 4.8%. Applying the cost of equity of 7.1% and the supernormal growth model, compute the intrinsic price of Flyers.

18. (8 points) Hayley Motorcycle Company just paid a dividend of $1.3 today, and is expected to pay a dividend in year 1 of $1.7, a dividend in year 2 of $2, a dividend in year 3 of $2.6, and a dividend in year 4 of $4. After year 4, dividends are expected to grow at the rate of 1.1% per year. An appropriate required return for the stock is 7%. Using the different- stage growth model, the stock should be worth __________ today.

19. (10 pts) Doolittle Co. is expected to pay a dividend of $2.2 next year. Doolittle is expected to pay 20% of its earnings as dividends and will have an ROE of 8.2% until the fourth year. After that, its ROE is expected to decrease to 3.3% and the dividend payout ratio will increase to 30%. Applying the cost of equity of 9.3% and the supernormal growth model, compute the intrinsic price of Doolittle.

20. (17 points) Kirk Inc. has come out with a new and improved product, and is expected to have an ROE of 17.6%. It will maintain a plowback ratio of 30%. Investors expect a 7.3% rate of return on the stock.

(a) (4 pts) at what P/E ratio would you expect Kirk to sell?

(b) (8 pts) Kirk is expected to report an EPS of $5 for next year. Assuming Kirk's current value is measured with the constant growth DDM, compute the present value of growth opportunities for Kirk.

(c) (5 pts) If the present value of growth opportunities = 0, find the ROE for Kirk and explain why. Assume all else remain constant. (HINT: It is an intuitive question. While you need to give a number for an answer, you DO NOT need to do any calculation.)