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FINA312 / FINA517 – SEMESTER B 2010

TUTORIAL – SESSION 05

CHAPTER 18

1. The _______ is defined as the present value of all cash proceeds to the investor in the stock.

A. dividend payout ratio

B. intrinsic value

C. market capitalization rate

D. plowback ratio

E. none of the above

The cash flows from the stock discounted at the appropriate rate, based on the perceived riskiness of the stock, the market risk premium and the risk free rate, determine the intrinsic value of the stock.

2. The ______ is a common term for the market consensus value of the required return on a stock.

A. dividend payout ratio

B. intrinsic value

C. market capitalization rate

D. plowback rate

E. none of the above

The market capitalization rate, which consists of the risk-free rate, the systematic risk of the stock and the market risk premium, is the rate at which a stock's cash flows are discounted in order to determine intrinsic value.

3. The Gordon model

A. is a generalization of the perpetuity formula to cover the case of a growing perpetuity.

B. is valid only when g is less than k.

C. is valid only when k is less than g.

D. A and B.

E. A and C.

The Gordon model assumes constant growth indefinitely. Mathematically, g must be less than k; otherwise, the intrinsic value is undefined.

4. You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C _____.

A. will be greater than the intrinsic value of stock D

B. will be the same as the intrinsic value of stock D

C. will be less than the intrinsic value of stock D

D. cannot be calculated without knowing the rate of return on the market portfolio.

E. none of the above is a correct statement.

PV0 = D1/(k-g); given that dividends are equal, the stock with the higher growth rate will have the higher value....