1. Distinguish between the intrinsic price of a share of common stock and its current market price. Why might they differ? How does the concept of market efficiency fit into this distinction?
2. Mr. Jim owns 1,500 shares of stock in Company X. Company X's 18,750 shares outstanding are publicly traded and come with a pre-emptive right. They are currently trading at $27 per share. Company X is considering issuing 10,500 new shares to help finance the purchase of additional plant and equipment. If Mr. Jim wishes to maintain his proportionate ownership in the company, what is the additional dollar amount he will be required to make assuming he can purchase the new shares from the company at a 5% discount?
3. The last observed dividend for Company Z before today was $2.15. Dividends are growing at a constant rate of 8.5% annually. If the required rate of return on the stock is 12.5%, what will be the total expected dollar capital gain per share on the stock three years from today? Assume dividends are paid annually.
4. Based on rational investor behavior, why is it reasonable to assume that the denominator in the constant growth rate model will be positive? ("Because the stock price would be negative" is not the answer. Use an economic, not a mathematical argument. )
5. Using the constant growth rate model (and data from Bloomberg) shows that the present value of expected dividends for the next five years for McDonald's is only about $1.98. Thus, over a forward-looking five-year horizon the value of the stock is $1.98. Yet on this same date McDonald's stock is selling among investors in the secondary market for $24.83 per share. How can such a large discrepancy in the two dollar values on the same date be explained?
6. List and briefly explain two reasons why the free cash flow model of stock price determination is superior to conventional dividend discount models of stock price determination.