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Stock Valuation Practice Questions

The document contains practice questions related to preferred stock valuation, common stock value under zero growth and constant growth models, variable growth stock valuation, and business valuation using growth-based models. Each question requires calculations based on given financial data, including dividends, required rates of return, and growth rates. The questions aim to assess understanding of stock valuation principles and investment analysis.

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Anas Sheikh
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38 views2 pages

Stock Valuation Practice Questions

The document contains practice questions related to preferred stock valuation, common stock value under zero growth and constant growth models, variable growth stock valuation, and business valuation using growth-based models. Each question requires calculations based on given financial data, including dividends, required rates of return, and growth rates. The questions aim to assess understanding of stock valuation principles and investment analysis.

Uploaded by

Anas Sheikh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

practice question 1:

Preferred stock valuation


Jones Design wishes to estimate the value of its outstanding preferred stock. The preferred
issue has an $80 par value and pays an annual dividend of $6.40 per share. Similar-risk
preferred stocks are currently earning a 9.3% annual rate of return.

a. What is the market value of the outstanding preferred stock?

b. If an investor purchases the preferred stock at the value calculated in part a, how much
does she gain or lose per share if she sells the stock when the required return on similar-risk
preferred stocks has risen to 10.5%? Explain

practice question 2:

Personal Finance Problem


Common stock value—Zero growth
Kelsey Drums, Inc., is a well-established supplier of fine percussion instruments to
orchestras all over the United States. The company's class A common stock has paid a
dividend of $5.00 per share per year for the last 15 years. Management expects to continue
to pay at that amount for the foreseeable future.

Sally Talbot purchased 100 shares of Kelsey class A common 10 years ago, at a time when the
required rate of return for the stock was 16%. She wants to sell her shares today. The current
required rate of return for the stock is 12%.

Question:
How much capital gain or loss will Sally have on her shares?

practice question 3:

Common stock value—Constant growth


Use the constant-growth model (Gordon growth model) to find the value of each firm shown
in the following table.

Firm Dividend Expected Dividend Growth Required Return


Next Year Rate

A $1.20 5% 13%

B $4.00 10% 14%

C $6.00 8% 12%

D $3.00 6% 10%
practice question 4:

11. Common stock value—Variable growth


Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During
the year just completed, Grips earned $4.25 per share and paid cash dividends of $2.55 per
share (D₀ = $2.55).

Grips’ earnings and dividends are expected to grow at 2.5% per year for the next 3 years,
after which they are expected to grow at 10% per year to infinity.

What is the maximum price per share that Newman should pay for Grips if it has a required
return of 15% on investments with risk characteristics similar to those of Grips?

practice question 5:

Business Valuation—Growth-Based Models


You are analyzing the potential purchase of a small enterprise currently generating $58,000
of annual after-tax cash flow (treated as dividends). Based on comparable investments with
similar risk profiles, you require a 15% rate of return on your investment. Due to uncertainty
about future cash flows, you decide to estimate the business’s value under three different
growth scenarios.

1. What is the firm's value if cash flows are expected to grow at an annual rate of 0%
indefinitely?
2. What is the firm's value if cash flows are expected to grow at an annual rate of 5%
indefinitely?
3. What is the firm's value if cash flows are expected to grow at an annual rate of 8% for the
first 3 years, followed by a constant annual rate of 5% from year 4 onward?

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