Question

1. The last dividend on Spirex Corporation’s common stock was $4.00, and the expected growth rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?

A. $44.00

B. $38.50

C. $40.00

D. $45.69

2) Which of the following statements is correct?

      A. A mature firm will have a higher cost of capital than a firm in the growth phase.

      B.   A mature firm will have a higher dividend yield than a firm in the growth phase.

      C. A mature firm will have a higher capital gains growth than a firm in the growth phase.

      D. Both B and C are correct.

3)   A share preferred stock pays a dividend of $0.50 each quarter. If investors are willing to pay $20.00 for this preferred stock, what is the nominal, not effective, component cost of capital?

A. 10%

B. 8%

C. 6%
D. 12%

4)   Which of the following methods to estimate the cost of capital for equity capital will lead to the highest estimate?

A. DCF.

B. CAPM.

C. Bond Yield plus Risk Premium.

D. Can not tell from the information provided.

Answer 1

ANSWER

1)

Highest Share Price as per GORDON MODEL:

= Expected Dividend / (Required Return - growth rate)

= Do (1 + g) / (Ke - g)

= $ 4 (1.10) / (0.20 - 0.10)

= $ 4.4 / 0.10

= $ 44

option (A)

2)

Correct Answer Option (D)

Reason Mature Firm has Lower Cost and Higher Returns than the firms in Growth phase because of the fact that they get Get Funds available at a Lower Cost since the amount of Risk attached is Lower as compared to the Risk which is involved with Firms in Growth Phase. Also Firms in Growth phase needs more funds to invest hence they prefer lower dividends unlike firms in Mature phase.

3)

Cost of Preferred Stock = (Annual Dividend / Price) * 100

= ( $0.50 * 4) / $ 20 * 100

= ($ 2 / $ 20) * 100

= 10 %

option (A)

4)

Correct Answer Option (D)

Cannot tell from this much information that which Method will lead to Highest Estimate of Cost of Equity.