[The following scenario for the dividend growth model applies to the next four questions.]
! The risk-free rate is 3.2%, the market risk premium is 8.2%, and a firm’s CAPM $ is 1.257.
! In 20XX, the firm’s after-tax earnings per share are 9.04, and its payout ratio is 70% each year.
! Earnings are expected to grow indefinitely at a constant rate.
! The firm’s ROE = ratio of earnings to book value of equity = 16.5%.
Question 1.31: Dividend growth model earnings per share
What is the firm’s growth rate of earnings per share?
A. 3.96%
B. 4.21%
C. 4.46%
D. 4.70%
E. 4.95%
Question 1.32: Dividend growth model stock price
What is the firm’s stock price after the dividend payment in 20XX if it retains its current dividend payout ratio?
A. 65.985
B. 69.867
C. 73.748
D. 77.630
E. 81.511
Question 1.33: Dividend growth model no growth stock price
What would the firm’s stock price be after the dividend payment in 20XX if it paid all earnings as dividends
in 20XX+1 and subsequent years?
A. 66.729
B. 70.241
C. 73.753
D. 77.265
E. 80.777
Question 1.34: Dividend growth model present value of growth opportunities
What is the firm’s present value of growth opportunities (PVGO) right after the dividend payment in 20XX?
A. 0.743
B. 3.886
C. 7.389
D. 3.516
E. 0.735
Question 1.35: Option Combinations
A stock trades now at $50. Three month European options trade with strike prices of $45, $50, and $55. The
risk-free interest rate is 4% per annum.
An investor buys one call option with a $55 strike price and one put option with a $45 strike price. Which of
the following best reflects the investor’s view?
A. The stock is undervalued, and will rise 10% or more over the next 3 months.
B. The stock is overvalued, and will fall 10% or more over the next 3 months.
C. The stock price is volatile, and will rise or fall 10% or more over the next 3 months.
D. The stock price is stable, and will not change much over the next 3 months.
E. The investor is risk averse, and wishes to hedge against large movements in the stock price. This option
combination provides the same return whether the stock price moves a small or large amount.