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Finance 350 Exam 3
Exam time: 50 mins
Name___________________________________
This is a closed-book exam. You are allowed to bring one 8 ½ x 11 HANDWRITTEN sheet of information of your choosing. Scientific calculators and financial calculators are permitted for exams, however, no other electronic devices are allowed. Answer all questions and show necessary work. 7 Pages in total.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question (Question 1 – 7 you are worth 5 points each. ) 1. Which of the following is best suited for dividend discount model? a. GM: a company tries very hard to maintain a stable dividend payment (around $1.20 per share annually), although GM’s earning is very volatile. b. Tesla: a company in growth phase. Tesla has bright future and a lot growth opportunities and no “free cash” to pay dividend.
c. Dr. Gu’s homemade cheesecake: a small private firm. You are trying to buy 51% of its share and become the owner. d. Newmart: a boring supermarket chain in U.K. with stable earning and stable dividend payout ratio (as percentage of earning). e. All of the above
2. Which of the following is not discounted cash flow model?
a. Residual income model. b. Dividend discount model c. Free cash flow model d. P/E ratio comparison e. All of the above are discounted cash flow model
3. According dividend discount model, which of the followings is not relevant to the value of stock? a. Dividend in year 1. b. Growth rate
c. Beta of stock
d. Risk free rate e. All of the above are related to the value of a stock
4. Which of the following is not an alternative name for residual income? a. Economic value added b. Abnormal earnings c. Economic profit
d. Operating income
e. All of the above are alternative names for residual income
5. A key input into your discount dividend model is the expected growth in perpetuity. For a company in growth phase, which of the following methods is not appropriate?
a. Use industry average
b. Use macroeconomic growth rate projection
c. use g=retention ratio*ROE, where ROE is the current ROE of the firm
d. use g=retention ratio*r, where r is the required return on equity
e. All of the above are appropriate
6. Which of the following is the best description of the free cash flow to the firm? A. It is the income after considering the costs of equity.
B. It is the income after considering the costs of debt.
C. It is the income after considering the costs of all of a company’s capital.
D. It is the cash left over after meeting debt payments and paying taxes.
E. None of the above.
7. Which one of the following statements relating to the strength of residual income model is incorrect?
a. Less weight on terminal value.
b. Appealing focus on economic profitability
c. Not affected by manipulation of accounting information by management
d. All of the above (a.,b.,c) are correct
e. All of the above (a.,b.,c) are incorrect.
Problems. Write your answer in the space provided. Please show your work. 8. Use the following information 2013
2014
Book value per share
19.62
?
Dividend per share
1.74
1.88
Earnings per share
5.88
6.74
The company’s beta is 0.9, risk free rate is 3%, equity risk premium is 5%. a.
Find the book value per share in year 2014, assuming the number of shares outstanding is constant (5)
b.
Find the residual income in year 2014 (Hint: use CAPM) (5 pts)
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9. For the next four years, the annual dividends of a stock are expected to be $2.00, $1.50, $2.50, and $5.00. The required return on equity is 11%.
a. If you believe the stock price is expected to be $50.00 in four years. What is the value of the stock? (5 pts)
b. You found your assumption in a is suspicious. You decide to look at future dividends instead. After fourth year, you expect the stock’s dividends to grow at 3% forever. What is the value of the stock at the end of year THREE? AND what is the value of the stock today? (10 pts)
10. Berc Hatway Inc shareholders on Saturday (May 2
nd
) celebrated Barron Wolfe's 50th anniversary running the conglomerate, as the billionaire expressed optimism the company would thrive over the long haul, even after he is gone. Barron even played
the ukulele in a video prior to the annual meeting. True, he wasn’t in tune. But investors responded positively. Berc Hatway’s stock closed at $215,000 per share on Friday (May 1
st
) and opened at $220,000 per share on Monday (May 4
th
). Berc Hatway’s current dividend per share (D0) is $5,000 per share. Beta is 0.2. The risk free rate is 3%, equity risk premium is 10%. Use constant dividend growth model.
a.
What were the implied growth rates on Friday and Monday? (8 pts)
b.
The company’s expected earning in next year is $12000 per share. What is the PVGO based on Monday’s stock price? (6 pts)
c.
The estimated growth rate of Berc Hatway's dividend is 2%. Estimate the justified trailing and leading PE ratios of Berc Hatway's stock using Gordon Growth Model (6 pts)
11. Use the following information
Year 0 Year 1 Year 2
Earnings per
share
$2.50
$3.00
Dividend per
share
$1.00
$1.20
Book value per
share $20.00 $21.50 $23.30
Cost of equity
10%
a.
After second year, you expect the stock’s dividends to grow at constant rate forever. Assume this company will have the same ROE and payout ratio after year 1. Estimate the
dividend growth rate after year 2. AND estimate the value of the stock based on dividend discount model (10 pts)
b.
Find the value of stock using residual income model. Assume that the company continues
operation after two years and continuing residual income is constant from year 2 to eternity (10 pts)
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12. Accountants are very conservative. The conservatism make the accounting value of asset very different from the intrinsic value. However, it seems residual income model overcomes this problem. For example, if we have a company that:
i. All earnings are paid out as dividends so book value is constant
ii. Earnings and dividends are constant forever
iii. Earnings per share is $1.00
iv. Required return on equity is 10%
If we assume the initial book value is $7.00 per share.
Then V0=7+(1-10%*7)/10%==$10
If we assume the initial book value is $10.00 per share.
Then V0=10+(1-10%*10)/10%==$10
You can see the initial book value is irrelevant to the value of the stock. a.
Briefly explain the phenomenon. (5 pts)
b.
Under what condition can book value affect the residual income valuation? (Please just give one condition) (5 pts)
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Oriole Supply Co. has the following transactions related to notes receivable during the last 2 months of 2020. The company does not make entries to accrue interest excer
ES-
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a) Will credit cards help? The average undergraduate student leaves college with a diploma and
around $2750 in credit card debt (graduate students; $4800). Suppose you have a credit card with a
balance of $2750 and an interest rate of 19.8% APR. The minimum payment is $45.00. The amount
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1
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$45.00
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$2750.38
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$45.00
4
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$45.00
$45.00
$45.00
8.
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9.
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10
$45.00
11
$45.00
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