The dividend growth model: a. is only as reliable as the estimated rate of growth. b. can only be used if historical dividend information is available. C. considers the risk that future dividends may vary from their estimated values. d. applies only when a firm is currently paying dividends. e. uses beta to measure the systematic risk of a firm.

The dividend growth model: a. is only as reliable as the estimated rate of growth. b. can only be used if historical dividend information is available. C. considers the risk that future dividends may vary from their estimated values. d. applies only when a firm is currently paying dividends. e. uses beta to measure the systematic risk of a firm.

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter13: Valuation: Earnings-based Approach

Section: Chapter Questions

Problem 1QE

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One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investments. Explain what a residual policy implies (assuming that all distributions are in the form of dividends), illustrating your answer with a table showing how different investment opportunities could lead to different dividend payout ratios.
An analyst is trying to determine the intrinsic value of a certain share. Which of the following is true with regards to the methods of stock valuation? a. Discounting techniques does not involve forecasting future dividends b. Free cash flow is important in discounted dividend model c. Aside from the intrinsic value, the market value of the firm can also be determined by free cash flow model d. Non-constant growth stock is valuated in the same way as preferred stock
Which one of the followings is incorrect regarding to cost of equity: On average, it is higher than cost of debt. It moves in the same direction with tax rates. It is affected by return on market portfolio. For a dividend paying company, it is sensitive to growth expectations for future dividends. It is highly dependent on risk level of the firm and growth rate. For calculating cost of equity, we can rely on dividend growth model or SML approach. Both models might suffer from the assumption that past is a good predictor of future. True False Percy's Wholesale Supply has earnings before interest and taxes of €106,000. Both the book and the market value of debt is €170,000. The unlevered cost of equity is 15.5 per cent while the pre-tax cost of debt is 8.6 per cent. The tax rate is 28 per cent. What is the firm's weighted average cost of capital? Show your steps.
Which statement below is incorrect? Select one: A. Compared to interview, survey is more suitable to ask standardised questions. B. If a firm has more intangible assets, according to the trade-off theory, it is more likely to have a higher leverage. C. If a firm is more profitable, according to the pecking order theory, it should use less debt for financing. D. The CAPM model implies that a stock with a higher beta has a higher return on average.
Using the dividend growth model, why would a firm be hesitant to reduce the growth rate of its dividends.
Which of the following statements is correct? A. The optimal dividend policy is the one that satisfies management, not shareholders. B. The use of debt financing has no effect on earnings per share (EPS) or stock price. C. Stock price is dependent on the projected EPS and the use of debt, but not on the timing of the earnings stream. D. The riskiness of projected EPS can impact the firm's value. E. Dlvidend policy is one aspect of the firm's financial policy that is determined solely by the shareholders. Reset Selection
a. What is the relationship between the expected return of a stock and its fair expected return? When is a stock underpriced, overpriced, or fairly priced? b. Explain what happens to the firm’s cost of equity, cost of debt, and cost of capital when the firm increases the amount of debt in its capital structure. Assume all Modigliani and Miller assumptions hold and that there are no taxes. c. How can we use the internal rate of return to evaluate whether we should pursue a specific project? Should we pursue a project when the cost of capital is higher than the internal rate of return?
The dividend discount model is used by most equity analysts to determine a stock’s intrinsic value. The most popular of the models is the two-stage constant growth model. What is the rationale for valuing a firm using the two-stage dividend discount model versus other valuation methods?
One position expressed in the financial literature is that firms set their dividends as aresidual after using income to support new investment.a. Explain what a residual dividend policy implies, illustrating your answer with a tableshowing how different investment opportunities can lead to different dividend payoutratios.b. Think back to Chapter 14 where we considered the relationship between capital structureand the cost of capital. If the WACC-versus-debt-ratio plot was shaped like a sharp V,would this have a different implication for the importance of setting dividends accordingto the residual policy than if the plot was shaped like a shallow bowl (a flattened U)?
In examining investors’ preferences for dividends, it is useful to begin with the concept of dividend irrelevance. Dividend irrelevance suggests that in a world with no taxes or brokerage (or transaction) costs, firms and investors are indifferent to the paying or receiving of dividends. However, as these restrictions are relaxed, various factors suggest that firms should pursue high or low payouts. One such factor is: Dividends received far into the future are significantly more uncertain than dividends received in the near future. Based on the factor described, identify whether investors, in general, will tend to favor high or low payout ratios. Favor a high payout Favor a low payout
If the Modigliani and Miller hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct? Group of answer choices None of these statements is true. All of these statements are true. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a + b(g)) would be equal to +1.0. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.
Wyden Brothers uses the CAPM to calculate the cost of equity capital. The company’s capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company’s WACC? a) A reduction in the market risk premium. b) An increase in the risk-free interest rate. c) An increase in the beta of the company’s stock. d) An increase in expected inflation. e) An increase in the flotation costs associated with issuing preferred stock.