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Class Notes
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Canada
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McMaster University
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Economics
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ECON 2I03
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Usman Hannan
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Lecture

Description

Ch 6: Valuing Stocks
Spider Gold Mine is increasing next year’s dividend to $5 per share. The forecast
stock price next year is $105. Equally risky stocks of other companies offer
expected rats of return of 10%. Next 2 questions.
1) What should Spider’s common stock sell for?
a) $100
b) $105
c) $110
d) $5
e)$101
Ans: a) 100
Checkpoint: 6.3
2) Batman is trying to out-beat the market. He has done a ‘fundamental analysis’ of
Spider Stock and thinks the stock is undervalued. Batman can reasonably expect to
out-beat the market if:
a) Spider stocks have shown ‘new-issue puzzle’ previously.
b) Behavioral finance is taken into account.
c) Gold Mine stocks are showing signs of overconfidence by shareholders right
now.
d) The gold mine stock market has weak form efficiency.
Ans: d) The gold mine stock market is having weak form efficiency.
Leture
3) TSX stock prices follow random walk. This means:
a) Successive stock prices are not related.
b) Stock prices fluctuate above and below a normal long-run price.
c) The history of stock prices can be used to predict future returns to investors.
d) Successive stock price changes are not related.
Ans: d) Successive stock price changes are not related.
Checkpoint 6.9
4) Lion Stock will pay a dividend this year of $2.40 per share. Its dividend yield is 8
percent. At what price is the stock selling?
a) $2.4
b) $24
c) $30
1 d) $31
e) $32
Ans: c) $30
Problem 2
5) BMM Industries pays a dividend of $2 per quarter. The dividend yield on its stock
is reported at 4.8 percent. What price is the stock selling at?
a) $8
b) $166.7
c) $165.8
d) $177.7
e) $ 178.7
Ans: b) $166.7
Problem 7
6) Kangaroo is a financial manager at the Dinosaur corp, whose shares are traded
publicly. Why might he need to learn how to value stocks as a manager?
a) All publicly traded stock prices are posted regularly on major newspapers and
financial websites. What if they are posted wrongly?
b) Dinosaur corp’s stock price reflects the corp’s market value.
c) Dinosaur corp’s stock price is a substantial representative of the corp’s book
value.
d) Manager’s should know some accounting, and learning how to value the market
price of stocks is an essential prerequisite for it.
Ans: b) Dinosaur corp’s stock price reflects the corp’s market value.
Lecture
7) Chakku Inc. (specialist in making knives) will pay a dividend of $5 per share in 1
year. It sells at $50 a share, and firms in the same industry provide an expected rate
of return of 14 percent. What must be the expected growth rate of the company’s
dividends?
a) 4%
b) 14%
c) 2.5%
d) 4.5%
e) 5%
Ans: a) 4%
Problem 14
Donkey & Donkey Inc. is a declining industry. Its sales, earnings and dividends are
shrinking at a rate of 10% per year. r = 15% and Di1 = $3. Next 3 questions.
2 8) What is the present value of a share?
a) $8
b) $9
c) $10
d) $11
e) $12
Ans: e) $12
Problem 17
9) What is the approximated forecasted price for the stock next year? (ignore
decimals by rounding up)
a) $8
b) $9
c) $10
d) $11
e) $12
Ans: d) $11
Problem 17
10) Which one is most sound?
a) Investing in Donkey will yield a negative expected rate of return.
b) If the stock market truly exhibits random walk, then Donkey stock price would
ultimately become negative.
c) Investing in Donkey will yield a fair rate of return if the market is having weak-
form efficiency.
d) Ultimately Donkey will become bankrupt.
Ans: c) Investing in Donkey will yield a fair rate of return if the market is having
weak-form efficiency.
Problem 17 and lecture
11) While attending a shareholder meeting , James heard the following five
comments from five of his fellow-shareholders . Which one do you think James
ought to take as a true statement?
a) Investors may obtain the same securities at the same time in either the primary or
secondary markets.
b) Cash dividends are offered to shareholders in lieu of increasing the stock's price.
c) The dividend discount model does not hold for investors who have a preference
for capital gains.
d) The dividend discount model should not be used to value stocks in which the
dividend does not grow.
e) Holding risk constant, an increase in dividend yield will tend to decrease a firm's
rate of growth.
3 Ans: e) Holding risk constant, an increase in dividend yield will tend to decrease a firm's
rate of growth.
Lecture
Ch 7: Net Present Value and Other Investment Criteria
Egg is thinking of investing in a computer project that costs $3,000, but will
generate $660 cash flows annually for 7 years. The opportunity cost of capital is 6%.
Next 4 questions.
12) Payback period is:
a) 3.6 years
b) 4.6 years
c) 5.6 years
d) 6.6 years
e) 7.6 years
Ans: b) 4.6 years
Checkpoint 7.2
13) Discounted payback period is:
a) 3.5 years
b) 4.5 years
c) 5.5 years
d) 6.5 years
e) 7.5 years
Ans: c) 5.5 years
Checkpoint 7.2
14) NPV is:
a) $3684
b) $3000
c) $584
d) $684
e) $784
Ans: d) $684
Checkpoint 7.2
15) Best one? :
If Egg’s cutoff period for the investment is 5 years, then he should accept the project
a) if payback criteria is used.
b) if discounted payback criteria is used.
c) if either of payback or discounted payb

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