- Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? Please use the given general Dividend Growth Model formulas to help you answer the question.
Stock Price per share at Year 0 = [Dividends per share (“DPS”) expected for Year 1]
divided by
[Required Return less Dividend Growth Rate g]
Required Return = DPS/Price + g
Common stock: A B
Required Return…………………… 15.00% 16.00%
Market Price………………………… $25.00 $40.00
Expected Dividend growth rate…. 6.00% 9.00%
What is the Dividend Yield for these two stocks?
A. 8.00% for A and 5.00% for B.
B. 3.00% for A and 3.00% for B.
C. These two stocks should have the same expected return.
D. 9.00% for A and 7.00% for B.
2. Wilson-Smith Inc.’s capital structure is briefly described below. Compute the company’s Weighted Average Cost of Capital (“WACC”). The company’s marginal income tax rate is 28%.
Capital % of Capital Structure Pre-Tax Cost
Bonds……………35%…………………….6.80%
Preferred Stock..15%…………………….9.50%
Common Stock..50%……………………23.00%
= .35*6.8*(1-.28) + .15*9.5 + .5*23
A. 16.70%
B. 14.64%
C. 18.40%
D. 14.59%
3. Diana is looking at two investment opportunities which have the following expected cash flows. If her minimum required return is 16%, which proposal would be the best based on what appears to be the best evaluation method?
Investment A Investment B
Year 0…………………………………..$ (567,000) $ (567,000)
Year 1…………………………………..$ 154,000 $ 156,000
Year 2…………………………………..$ 287,000 $ 291,000
Year 3…………………………………..$ 260,000 $ 290,000
Year 4…………………………………..$ 155,000 $ 145,000
A. Neither proposal would add value.
B. Choose Proposal A because it has the highest IRR.
C. Choose Proposal B because it has the highest NPV.
D. Chyoose Proposal A because it has the highest NPV.
E. Choose Proposal B because it has the highest IRR.
- Wilson-Smith Inc.’s capital structure is briefly described below. Compute the company’s Weighted Average Cost of Capital (“WACC”). The company’s marginal income tax rate is 28%.
Capital % of Capital Structure Pre-Tax Cost
Bonds……………35%…………………….6.80%
Preferred Stock..15%…………………….9.50%
Common Stock..50%……………………23.00%
= .35*6.8*(1-.28) + .15*9.5 + .5*23
A. 16.70%
B. 14.64%
C. 18.40%
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