# If a common stock has a constant dividend, year over year, True or False the current price (i.e....

## Question:

If a common stock has a constant dividend, year over year, True or False the current price (i.e. resent value) for a common stock can be determined based on a general valuation model used for the dividend.

a. True, may use the preferred stock valuation method

b. False, may NOT use the preferred stock valuation method

A bond with a $1,000 par value has seven years remaining until maturity. The bond pays annual interest payments based on a coupon of 8.00 percent. The yield to maturity for this bond, based on the trading prices for other similar bonds, is 9.00 percent. What is this bond's current trading price (i.e. what is the bond's present value)? a.$1,000.00

b. $1, 051, 54 c.$949, 64

d. $1, 065.20 A preferred stock with a par value of$100 bear>> a dividend yield (i.e. a stared rate of return) of 11.00 percent. The trading prices for other similar preferred stocks re-fleet a required rate of return of 10.00 percent for this security. This stock should trade at a value

a. greater than its par value of $100.00 b. less than its par value of$100.00

c. equal to its par value of $100.00 d. that cannot be determined based on the given information. Preferred stock dividend is$11, and die required rate of return is 10%, what are the value/trading price of the preferred stock? Is

a. $90.91 b.$110.00

c. $100.00 d. cannot be determined based on the given information. Common stock is expected to pay a dividend of$5.00 at the end of next year. The dividend is expected to grow thereafter at a rate of 5.00 percent annually. The required rate of return for this security is 20.00 percent. We would expect this common stock to trade at a current price of

a. $50.00 b.$25.00

c. $100.00 d.$33.33

Which of the following forms of financing has a tax advantage over the others?

a. Trade credit

b. Debit

c. Preferred Stock

d. Common Stock

## Cost of Capital

The term cost of capital refers to the overall cost or weighted average cost of capital (WACC). Computation of WACC involves two steps (1) calculation specific cost of each source of finance (equity, debt, preferred stock, retained earnings) and (2) assigning weights to each source and calculating the WACC

## Answer and Explanation:

Answer is a. true

If a common stock has a constand dividend ( or zero growth), the current price or value of stock would be equal to the present value of dividends for an indefinite period of time,

Symbolically, P0 = D1 / Ke

where P0 is current price

D1 is expected dividend

Ke is cost of equity capital

• The above formula is used for valuation of preferred stock also

Answeris c.$949.64 • The yield to maturity of YTM of a bond can be determined using the following approximation formula {eq}YTM = \frac{I + \frac{FV - MP}{n}}{\frac{FV + MP}{2}} {/eq} where YTM is given as 9% or 0.09 I is the annual interest, which is 8% of 1000 = 80 ""FV is face value, given as 1000 n is number of years, given as 7 MP is market price which is to be determined • Putting the values in the formula, we get {eq}0.09 = \frac{80 +\frac{1000 - MP}{7}}{\frac{1000 + MP}{2}} {/eq} {eq}0.09 = \frac{\frac{560 + 1000 -MP}{7}}{\frac{1000 + MP}{2}} {/eq} {eq}\frac{2(1560 - MP)}{7(1000 + MP)} = 0.09 {/eq} (3120 - 2MP) / (7000 + 7MP) = 0.09 3120 - 2MP = 630 + 0.63MP 2490 = 2.63MP MP =$946.77.

Answer a. greater than par value of $10 If the required rate of return ( given as 10%) is less than the stated rate of return (given as 11%), then the price of the security will be more than its par value, Such a security will be selling at a premium to its par balue. Answerb.$110

Required rate of return on preference stock = Dividend per share / Market value per share

0.10 = $11 / Market value per share Market value per share = 11 / 0.10 =$110

Answer is d. $33.33 • According to dividend discount model ,current price of equity share is calculated as follows: {eq}P0 = \frac{D1}{Ke - g} {/eq} where Po is current price of stock, which is to be determined, D1 is expected dividend a year hence, given as$5

Ke is required rate of return given as 0.20

g is growth rate in dividends, given as 0.05

• {eq}Po = \frac{5}{0.20 - 0.05} {/eq}

= 5 / 0.15 = \$33.33

Answeris b. Debt

Debt capital as tax advantage because interest expense on debt is a tax deductible expense

#### Learn more about this topic:

Capital Structure & the Cost of Capital

from Finance 101: Principles of Finance

Chapter 15 / Lesson 1
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