In the Gordon model, the value of the common stock is the (a) net value of all assets which are liquidated for their exact accounting value. (b) actual amount each common stockholder would expect to receive if the firm’s assets are sold, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders. (c) present value of a non-growing dividend stream. (d) present value of a constant, growing dividend stream.

In the Gordon model, the value of the common stock is the
(a) net value of all assets which are liquidated for their exact accounting value.
(b) actual amount each common stockholder would expect to receive if the firm’s
assets are sold, creditors and preferred stockholders are repaid, and any remaining
money is divided among the common stockholders.
(c) present value of a non-growing dividend stream.
(d) present value of a constant, growing dividend stream.
Answer: D
Level of Difficulty: 3
Learning Goal: 4
Topic: Constant Growth Valuation Model
52. Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of
dividends of 10 percent, and a required return of 20 percent. The value of a share of
Emmy Lou, Inc.’s common stock is _________.
(a) $28.00
(b) $56.00
(c) $22.40
(d) $18.67
Answer: B
Level of Difficulty: 3
Learning Goal: 4
Topic: Constant Growth Valuation Model (Equation 7.4 and Equation 7.5)
53. A firm has experienced a constant annual rate of dividend growth of 9 percent on its
common stock and expects the dividend per share in the coming year to be $2.70. The
firm can earn 12 percent on similar risk involvements. The value of the firm’s common
stock is _________.
(a) $22.50/share
(b) $9/share
(c) $90/share
(d) $30/share
Answer: C
Level of Difficulty: 3
Learning Goal: 4
Topic: Constant Growth Valuation Model (Equation 7.4 and Equation 7.5)
54. A common stock currently has a beta of 1.3, the risk-free rate is an annual rate of 6
percent, and the market return is an annual rate of 12 percent. The stock is expected to
generate a constant dividend of $5.20 per share. A toxic spill results in a lawsuit and
potential fines, and the beta of the stock jumps to 1.6. The new equilibrium price of the
stock
(a) will be $37.68.
(b) will be $43.33.
(c) cannot be determined from the information given.
(d) will be $33.33.
Answer: D
Level of Difficulty: 3
Learning Goal: 4
Topic: Constant Growth Valuation Model and CAPM (Equation 7.4, Equation 7.5, and
Equation 7.9)
55. A common stock currently has a beta of 1.7, the risk-free rate is 7 percent annually, and
the market return is 12 percent annually. The stock is expected to generate a constant
dividend of $6.70 per share. A pending lawsuit has just been dismissed and the beta of
the stock drops to 1.4. The new equilibrium price of the stock
(a) will be $55.83.
(b) will be $43.23.
(c) will be $47.86.
(d) cannot be determined from the information given.
Answer: C
Level of Difficulty: 3
Learning Goal: 4
Topic: Constant Growth Valuation Model and CAPM (Equation 7.4, Equation 7.5, and
Equation 7.9)
56. According to the efficient market theory,
(a) prices of actively traded stocks can be under- or over-valued in an efficient market,
and bear searching out.
(b) prices of actively traded stocks can only be under-valued in an efficient market.
(c) prices of actively traded stocks do not differ from their true values in an efficient
market.
(d) prices of actively traded stocks can only be over-valued in an efficient market.
Answer: C
Level of Difficulty: 4
Learning Goal: 4
Topic: Efficient Markets
57. Economically rational buyers and sellers use their assessment of an asset’s risk and
return to determine its value. Relative to this concept, which of the following is true?
(a) To a buyer the asset’s value represents the minimum price that he or she would pay
to acquire it.
(b) To a seller the asset’s value represents the maximum sale price.
(c) To a buyer the asset’s value represents the maximum price that he or she would pay
to acquire it.
(d) The interaction of buyers and sellers can result in a value that differs from the
stock’s true value.
Answer: C
Level of Difficulty: 4
Learning Goal: 4
Topic: Risk, Return and Market Efficiency
58. If expected return is less than required return on an asset, rational investors will
(a) buy the asset, which will drive the price up and cause expected return to reach the
level of the required return.
(b) sell the asset, which will drive the price down and cause the expected return to
reach the level of the required return.
(c) sell the asset, which will drive the price up and cause the expected return to reach
the level of the required return.
(d) buy the asset, since price is expected to increase.
Answer: B
Level of Difficulty: 4
Learning Goal: 4
Topic: Risk, Return and Market Efficiency
59. If the expected return is above the required return on an asset, rational investors will
(a) buy the asset, which will drive the price up and cause expected return to reach the
level of the required return.
(b) sell the asset, which will drive the price down and cause the expected return to
reach the level of the required return.
(c) sell the asset, which will drive the price up and cause the expected return to reach
the level of the required return.
(d) sell the asset, since price is expected to decrease.
Answer: A
Level of Difficulty: 4
Learning Goal: 4
Topic: Risk, Return and Market Efficiency
60. Following the theory of the “efficient market hypothesis” all of the following are true
EXCEPT
(a) securities are typically in equilibrium, meaning they are fairly priced and their
expected returns equal their required returns.
(b) the Ivan Boesky’s of the market have proven that stocks are not fully and fairly
priced, so investors should spend time searching for mispriced (over- or
under-valued) stocks.
(c) at any point in time, security prices fully reflect all public information available
about the firm and its securities, and these prices react swiftly to new information.
(d) since stocks are fully and fairly price, it follows that investors should not waste
their time trying to find and capitalize on miss-priced (under- or over-valued)
securities.
Answer: B
Level of Difficulty: 4
Learning Goal: 4
Topic: Efficient Markets