Question

18. You would use the dividend growth model (DGM) method to determine the value of a stock

a.for a stock that does not pay dividends.

b.with an unusual or non-constant growth pattern

c.when the growth rate of the stock is greater than the rate expected in the marketplace.

d.with the same dividend every time.

e.with a very stable, nominal growth pattern.

19.  A certain investment has an APR of 7% and an EAR of 7%.  From this information we know that:

a.One of the rates must be incorrect.

b.The investment actually earns 7.2%

c.This is not a good investment for several reasons.

d.The investment compounds quarterly.

e.The investment compounds annually.

20.  A grandmother would like to start a savings account for her grandchild when it is born and deposit $1,000, but then add no more to the account and let it earn interest at 5% until the child is 21. To find out how much will be in the account when the grandchild turns 21, you would do a

a.  multiple payment time value of money computation for future value.

b.  single payment time value of money computation for future value.

c.  multiple payment time value of money computation for present value.

d.  single payment time value of money computation for present value.

e.  None of the above will get to the value of the account after 21 years.

Answer 1

18. You would use the dividend growth model (DGM) method to determine the value of a stock

CORRECT ANSWER : e.with a very stable, nominal growth pattern.

THE FORMULA : P0 = D1/(ke-g)

HERE, WE TAKE g = CONSTANT GROWTH RATE FOREVER, D1 = EXPECTED DIVIDEND FOR NEXT YEAR

SO THE FORMULA SAYS (I) WE TAKE INTO ACCOUNT DIVIDEND SO "a" IS INCORRECT (II) WE TAKE g AS CONSTANT GROWTH RATE, SO THERE MAY BE UNUSUAL DIVIDEND FOR SOME YEARS BUT LATER ON IT HAS TO BE CONSTANT, SO "b" IS INCORRECT (III) FORMULA IMPLIES ke > g, SO "c" IS INCORRECT (IV) FORMULA CALCULATES D1, SO SAME DIVIDEND OPTION "d" IS ALSO INCORRECT.

19.  A certain investment has an APR of 7% and an EAR of 7%.  From this information we know that:

CORRECT ANSWER : a.One of the rates must be incorrect.

APR INDICATES AVERAGE YEARLY PERCENTAGE, EAR INDICATES EFFECTIVE ANNUAL RATE

SO EAR > APR, SO BUT OBVIOUS ANSWER IS "a".

AS EAR =7%, THE INVESTMENT CAN NOT EARN MORE THAN THAT SO "b" IS WRONG.

NO CRITERIA IS SPECIFIED FOR SELECTING INVESTMENT SO "c" CAN NOT BE CORRECT.

NO FURTHER INFORMATION IS GIVEN, SO WE CAN NOT DECIDE, IT IS QUARTERLY OR ANNUAL COMPOUNDING.

20.  A grandmother would like to start a savings account for her grandchild when it is born and deposit $1,000, but then add no more to the account and let it earn interest at 5% until the child is 21. To find out how much will be in the account when the grandchild turns 21, you would do a

ANSWER : b.  single payment time value of money computation for future value.

AS AMOUNT IS DEPOSITED IN SAVINGS ACCOUNTS ONCE ONLY & AMOUNT IS REQUIRED WHEN CHILD IS 21, IT IS A CASE OF SIMPLE FUTURE VALUE.

AS THE SINGLE AMOUNT IS DEPOSITED, IT IS NOT A CASE OF MULTIPLE PAYMENTS.

WE HAVE TO FIND OUT FUTURE VALUE OF SINGLE SUM AT THE END OF 21 YEARS @5%

SO ALL OTHER OPTIONS ARE INCORRECT