Multiple Choice Questions
1. Which of the following statements is true about the discount rate?
a. It is the reciprocal of the capitalization rate.
b. Tt represents the total compound rate of return that an investor in that class of investment expects to achieve over the life of the investment.
c. Tt represents the current yield.
d. Both (b) and (c) are true.
2. Which of the following statements is true about the relationship between discount and cap italization rates?
a. The discount rate equals the capitalization rate only for an investment whose returns are growing at a constant rate over time.
b. The discount rate and the capitalization rate are terms that are properly used inter changeably.
c. The discount rate equals the capitalization rate only when the expected returns in each period are equal in perpetuity.
d. The discount rate never equals the capitalization rate.
Discounting versus Capitalizing
3. Which of the following is a correct statement?
a. in discounting, changes in expected returns are reflected in the numerator, while in capitalizing, changes in expected returns after the first year are reflected in the denominator.
b. in discounting, changes in expected returns are reflected in (lie denominator, while in capitalizing, changes in expected returns after the first year are reflected in the numerator,
c. In both discounting and capitalizing, changes in expected returns after (he first year are reflected in the numerator,
d. in both discounting and capitalizing, changes in expected returns after the first year are reflected in the denominator.
4. If the expected rate of growth is constant in perpetuity, which of tlie following is a correct statement about the relationship between tlie discounting and capitalizing models?
a. The discounting model would be expected to produce a higher value than the capitaliz ing model,
b. The discounting model would be expected t.o produce the same value as tlie capitalizing model.
c. The discounting model would be expected to produce a lower value than (he capitaliz ing model,
d. Not. enough information is provided to determine wiiat (he relationship would be.
5. Which of the following is a correct statement about the midyear convention versus the year-end convention?
a. The midyear convention always produces a higher value than the year-end convention.
b. The year-end convention always produces a higher value than tlie midyear convention.
c. The midyear and year-end conventions produce the same value only when tlie cash flows are tlie same in every year,
d. Sometimes tlie midyear convention produces a higher value and sometimes the year-end convention produces a higher value, depending on the pattern of the cash flows.
6. in tlie discounting model, the terminal value is discounted for n + 1 periods. True False
7. in tlie discounting model, the longer the discrete projection period, tlie greater the impact of the terminal value on tlie total present value. True False
I. When the midyear convention is used in the discounting model for the discrete cash (lows, it is appropriate to use it for the terminal value as well. True False
9. The procedure by which the latest year's actual return is increased by a constant rate of growth and (lie result is divided by a capitalization rate is called:
10. The capitalization value of expected cash flows after the discrete projection period is called:
11. Given the following:
A noncallable peipetual preferred stock Pays $10 dividend per share at the end of each year [arket yield rate for preferred stocks of similar risk: 8%
Value the stock by the capitalization formula.
12. Given the following:
.rate 10%
Growth rate in perpetuity 4%
What is tlie capitalization rate?
13. Given the following:
Dividend in base period (period,-,) $1.00
Growth rate in dividend (compounded annually in perpetuity) 5%
Discount rate 12%
Usine tlie Gordon Growth Model, what is tlie value of one share of stock?
Given the following: Net Cash Flows
Year 1 Year 2 Year 3 Year 4 Year 5
SI 000 SI 200 S 1.400 SI 550 SI 700
Growth in perpetuity beyond year 5: 6% Discount rate: 20%
Compute the present value using the year-end discounting convention.
Given the same set of facts as in Exercise 13, compute the present value by the midyear capitalization convention.
Given the same set of facts as in Exercise 14, compute the present value by the midyear discounting convention.
More thematic eBooks are located at : capital stock