Investment Principles

Homework#3

Dr. Wikrom Prombutr

Question 1
ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%,
and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors
expect a 12% rate of return on the stock.

At what price would you expect ART to sell?

$25.00
$34.29
$42.86
none of the above

Question 2
ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%,
and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors
expect a 12% rate of return on the stock.

At what P/E ratio would you expect ART to sell?

8.33
11.43
14.29
none of the above

Investment Principles

Homework#3

Dr. Wikrom Prombutr

Question 3
ART has come out with a new and improved product. As a result, the firm projects an ROE of
25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share.
Investors expect a 12% rate of return on the stock.

What is the present value of growth opportunities for ART?

$8.57
$9.29
$14.29
none of the above

Question 4
ART has come out with a new and improved product. As a result, the firm projects an ROE of
25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share.
Investors expect a 12% rate of return on the stock.

What price do you expect ART shares to sell for in 4 years? ?

$53.96
$44.95
$41.68

Investment Principles

Homework#3

Dr. Wikrom Prombutr

none of the above

Question 5
A common stock pays an annual dividend per share of $1.60. The risk-free rate is 5 percent and
the risk premium for this stock is 4 percent. If the annual dividend is expected to remain at
$1.60 per share, what is the value of the stock?

$17.78
$32.00
$40.00
none of the above

Question 6
A firm has a return on equity of 30% and an earnings retention rate of 40%. Its sustainable
earnings growth rate is __________.

6%
10%
12%
18%

Question 7
Interior Airline is expected to pay a dividend of $3 in the upcoming year. Dividends are expected
to grow at the rate of 10% per year. The risk-free rate of return is 4% and the expected return
on the market portfolio is 13%. The stock of Interior Airline has a beta of 4.00. Using the

Investment Principles

Homework#3

Dr. Wikrom Prombutr

constant growth DDM (i.e. constand growth model or Gordon's growth model), the intrinsic
value of the stock is __________.

$10.00
$22.73
$27.78
$41.67

Question 8
Todd Mountain Development Corporation is expected to pay a dividend of $3.00 in the
upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of
return is 5% and the expected return on the market portfolio is 17%. The stock of Todd
Mountain Development Corporation has a beta of 0.75. Using the constant growth DDM (i.e.
constand growth model or Gordon's growth model), the intrinsic value of the stock is
__________.

4.00
17.65
37.50
50.00

Question 9
Annie's Donut Shops, Inc. has expected earnings of $3.00 per share for next year. The firm's ROE
is 18% and its earnings retention ratio is 60%. If the firm's market capitalization rate is 12%,
what is the value of the firm excluding any growth opportunities?

Investment Principles

Homework#3

Dr. Wikrom Prombutr

$25.00
$50.00
$83.33
$208

Question 10
Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming
year. Dividends are expected to grow at 8% per year. The riskfree rate of return is 4% and the
expected return on the market portfolio is 14%. Investors use the CAPM to compute the market
capitalization rate, and the constant growth DDM (i.e. constand growth model or Gordon's
growth model) to determine the value of the stock. The stock's current price is $84.00. Using the
constant growth DDM, the market capitalization rate (k) is __________.

9%
12%
14%
18%

Question 11
Rose Hill Trading Company is expected to have EPS in the upcoming year of $6.00. The expected
ROE is 18.0%. An appropriate required return on the stock is 14%. If the firm has a plowback
ratio of 70%, its intrinsic value should be __________.

$20.93
$69.77

Investment Principles

Homework#3

Dr. Wikrom Prombutr

$128.57
$150.00

Question 12
Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2.00, a dividend in
year 2 of $3.00, and a dividend in year 3 of $4.00. After year 3, dividends are expected to grow
at the rate of 7% per year. An appropriate required return for the stock is 12%. Using the
multistage DDM (i.e. Shifting Growth Rate Model), the stock should be worth __________
today.

$63.80
$65.13
$67.98
$85.60

Question 13
A coupon bond which pays interest semi-annually, has a par value of $1,000, matures in 5 years,
and has a yield to maturity of 8%. If the coupon rate is 10%, the intrinsic value of the bond today
will be __________.

$855.55
$1,000
$1,081
$1,100

Investment Principles

Homework#3

Dr. Wikrom Prombutr

Question 14
A bond presently has a price of $1,030. The present yield on the bond is 8.00%. If the yield
changes from 8.00% to 8.10%, the price of the bond will go down to $1,020. The modified
duration of this bond is __________.

-10.5
-8.5
9.7
10.5

Question 15
Ace Frisbee Corporation produces a good that is very mature in their product life cycles. Ace
Frisbee Corporation is expected to pay a dividend in year 1 of $3.00, a dividend in year 2 of
$2.00, and a dividend in year 3 of $1.00. After year 3, dividends are expected to decline at the
rate of 2% per year. An appropriate required return for the stock is 8%. Using the multistage
DDM (i.e. Shifting Growth Rate Model), the stock should be worth __________ today.

$13.06
$13.38
$18.25
$18.78

Question 16
Consider the following $1,000 par value zero-coupon bonds:

Investment Principles
Bond
A
B
C
D
E

Homework#3
Years to Maturity
1
2
3
4
5

Dr. Wikrom Prombutr

Yield to Maturity
6%
7.50%
7.99%
8.49%
10.70%

The expected one-year interest rate one year from now should be __________.

7.00%
8.00%
9.00%
10.00%

Question 17
If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant
information including historical stock prices and current public information about the firm, but
not information that is available only to insiders.

semi-strong
strong
weak
none of the above

Question 18
In an efficient market, __________.

Investment Principles

Homework#3

Dr. Wikrom Prombutr

security prices react quickly to new information

security prices are seldom far above or below their justified levels
security analysis will not enable investors to realize superior returns consistently
All of the above