FIN 3000 - Chapter 7 Part 2

The expected rate of return for a stock whose next dividend is "DIV1", that has a required rate of return "r" and expects to grow its future dividends at a rate of "g" is ________.

r = (DIV1/P0) + g

To determine a firm's sustainable growth rate, which three figures must remain constant?

return on equity, long-term debt ratio, and plowback ratio

A stock that pays out a perpetual stream of constant dividends can be valued as a(n) _________.

perpetuity

A stock's price is increasing in which of following variables?

A.) Required Rate of Return


B.) Yield to Maturity


C.) Growth Rate


D.) Dividend

C&D

In the constant growth dividend discount model, the expected return is equal to:

dividend yield + growth rate

The firm's growth rate if it plows back a constant fraction of earnings, maintains a constant return on equity, and keeps its debt ratio constant is the firm's __________________.

sustainable growth rate

If a stock has a required return of "r", its next dividend is expected to be "DIV1", and its dividends are expected to grow at a constant rate "g" thereafter, then its current share price "P0" can be determined by __________.

P0 = DIV1/(r-g)

The payout ratio is defined as:

the proportion of earnings to be paid out as dividends

The fraction of earnings reinvested in the firm is called the:

plowback ratio

The fraction of earnings paid out as dividends is a firm's:

payout ratio

If a firm's ROE is held constant, then ________ will grow in direct proportion to equity.

earnings per share

If ROE and the plowback ratio are held constant, then which of the following figures will increase at the sustainable growth rate?

A.) earnings
B.) book equity
C.) assets
D.) dividends

A&B&D

The plowback ratio is defined as the:

fraction of earnings retained by the firm

True or false: A constant growth can never exceed the required return.

True

If a company earns a constant return on equity and plows back a constant proportion of earnings, then its growth rate, g, is:

ROE x plowback ratio

The constant-growth formula does not work when there is a case of:

temporary rapid growth

Plowed back earnings will add to firm value when they are expected to earn:

higher than the rate of return that investors require

A firm's present value of growth opportunities (PVGO) can be defined as the net present value of the firm's:

expected future investment

Plowed back earnings may result in ______ and _______ growth, but it will not increase ______ if that money is expected to earn only the return that investors require.

earnings, dividend, stock price

A high P/E ratio generally means that a firm has:

good growth opportunities

Companies that grow rapidly for several years before settling down to a stable growth rate should use the ___________ for stock valuation.

non-constant growth model

Which dividend is used to calculate the horizon price, at time H?

DIVH+1

Using the discounted cash flow valuation formula, Rocky's Restaurant Group is valued at $42.13 per share. The firm's CFO expects the firm to grow 4% per year until the horizon date 12 years hence. Rocky's CFO recalculates growth at 5% per year. How will this change in growth affect the firm's valuation?

share price will increase by more than 1%

A firm that is experiencing rapid __________may see its free cash flow be zero or negative since it is reinvesting all of its earnings into new investments.

growth

A low P/E ratio generally means that a firm has:

high dividend payouts

The terminal value is defined as __________.

the stock price at the start of the year in which constant dividend growth begins

What describes the horizon year?

The last year of non-constant growth.

The year after which constant dividend growth is achieved.

Estimates of the terminal price generally account for a _______ proportion of a stock's value than estimates of the present value of forecasted dividends up until the horizon date.

greater

In addition to paying a dividend, a firm can return cash to its equity investors through a:

stock repurchase

Free cash flow may be _________ for rapidly growing businesses that are reinvesting all of their earnings into new investments.

negative

Companies that grow rapidly for several years before settling down to a stable growth rate should use the ___________ for stock valuation.

non-constant growth model

Stock repurchases are an attractive alternative to dividends because:

investors interpret dividends as repeated cash distributions

If you value the whole firm by applying the dividend discount model to _____________ , then you can find the share price by dividing the value of the firm by the current number of shares outstanding.

free cash flow

A firm hosts its quarterly investment call. News about the firm's earnings will be reflected in the firm's stock price within:

seconds or minutes

The random walk of stock prices dictates that a stock's price on any given day:

do not depend on previous stock price movement

If the firm uses repurchases instead of dividends to distribute returns to shareholders, how would the dividend discount model be modified to accommodate this?

Discount free cash flows instead of dividends, then divide by the number of shares to get share value

Statisticians have shown that the correlation coefficient between market movements in successive weeks is:

effectively zero

In a market where stocks are fairly valued, stock prices follow:

a random walk

A(n) ________ market is one in which prices reflect all available information.

efficient

Investors who buy stock in an IPO and receive an immediate gain followed by a longer term loss are experiencing an anomaly to the efficient market hypothesis called:

the new-issue puzzle

The type of market efficiency that asserts that no investor, including firm insiders, can earn superior returns is:

strong form efficiency

Successive week returns on the NY Composite Index show no significant relationship between returns; however, when you move to successive months,

the relationship remains unchanged

True or false: An efficient market absorbs new information immediately, thereby making it very difficult to detect undervalued stocks and to beat the market consistently.

True

A ________________ is characterized by prices that are at levels in excess of what would be justified economically.

bubble

The tendency for stock price increases to persist for 6-9 months and then to revert is an anomaly to the efficient market hypothesis called:

the momentum factor

The type of market efficiency that asserts that investors cannot earn superior returns through a study of information available to other investors is:

semi-strong form efficiency

Behavioral finance has shown that most investors are _________ in their ability to pick stocks that will offer superior returns.

overconfident

Investors who buy stock in an IPO and receive an immediate gain followed by a longer term loss are experiencing an anomaly to the efficient market hypothesis called:

the new issue puzzle

The type of market efficiency that asserts that investors cannot make superior returns by searching for patterns in past returns is _______.

weak form efficiency

The field of behavioral finance shows that _________ caused investors to pile more and more money into tech companies, causing the dot-com bubble.

attitudes toward risk

True or false: a market "bubble" is characterized by stock prices that are at levels in excess of what would be justified by expected dividends and earnings. In short, the market is seriously overpriced for some class of stocks.

True