The estimation of the marginal propensity to consume should be 2 ÷3
The computation of the estimation of the marginal propensity to consume is shown below:
But before that the multiplier should be
= Total demand for goods & services ÷ government spending
= $42 billion ÷ $14 billion
= 3
Now as we know that
Multiplier = 1 ÷ (1 - MPC)
3 = 1 ÷ (1 - MPC)
1 - MPC = 1 ÷ 3
MPC = 1 - 1 ÷3
= 2 ÷ 3
Therefore we can conclude that The estimation of the marginal propensity to consume should be 2 ÷3
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On Friday of each week, Prawn Company pays its factory personnel weekly wages amounting to $55,000 for a five-day work week.
Required:
a. Prepare the necessary adjusting entry at year end, assuming December 31 falls on Wednesday.
b. Prepare the journal entry for payment of the week’s wages on the payday which is Friday, January 2 of the next year.
Answer and Explanation:
The journal entry is shown below:
a.
Wages Expense $33,000 ($55,000 ÷ 5 days ×3days)
To Wages Payable $33,000
(being wages expense is recorded)
Here wages expense is debited as it increased the assets and credited the wages payable as it also increased the liabilities
b. Wages Expenses $22000
Wages Payable $33000
To Bank $55,000
(Being payment is recorded)
Here wages expense is debited as it increased the assets, the wages payable is also debited as it decreased the liabilities and credited the bank as it decreased the assets
Your firm is considering a project with a discount rate of 9%. If you start the projecttoday, your firm will incur an initial cost of $490 and will receive cash inflows of$365 per year for 3 years. If you instead wait one year to start the project, the initial cost will rise to $530 and the cash flows will increase to $405 a year for the following 3 years. Would your firm be better off starting the project now or waiting to start the project in a year? Explain clearly including an estimate of the value of the option to wait.
Answer:
If the company start the project today then NPV of the project,
Year Cash Flow PV of Cash flow
0 -490 -490
1 365 365/1.09= 334.86
2 365 365/1.09^2 = 307.21
3 365 365/1.09^3= 281.85
NPV = 433.92
NPV of Project0= $ 433.92
If a company start a project after one year,
Year Cash Flow PV of Cash flow
0 0 0
1 -530 -530/1.09= -486.24
2 405 405/1.09^2 =340.88
3 405 405/1.09^3 = 312.73
4 405 405/1.09^4 = 286.91
NPV = 454.28
NPV of Project1= $ 454.28
Here for project start after one year has more Net Present Value of cash flow compared to which start now.
So, Starting a project after one year is more profitable.
Pick the correct statement from below. Multiple Choice Project analysis should only include the cash flows that affect the income statement. A project can create a positive operating cash flow without affecting sales. The depreciation tax shield creates a cash outflow for a project. Interest expense should always be included when analyzing cost-cutting projects. A bid price maximizes profits on a project for the bidding firm.
Answer:
A project can create a positive operating cash flow without affecting sales.
Explanation:
A project cash flow analysis permits to look the cash inflows and cash outflows that are along with the existing or upcoming project. Also it addressed the opportunity cost
So as per the given situation, it involved that project in which it establish the positive operating cash flow without impacting the sales
Therefore as per the given options, the above statement represent an answer
A company changes from the straight-line method to an accelerated method of calculating depreciation, which will be similar to the method used for tax purposes. The entry to record this change will include a
Answer: c. credit to Accumulated Depreciation.
Explanation:
When using the accelerated method of depreciation, depreciation amounts are higher in the earlier years unlike the straight-line method where depreciation is constant throughout the life of the asset.
The difference between the depreciation according to Straight-line and depreciation will be sent to the accumulated depreciation account as a credit to reflect the change and the depreciation for the period.
You are considering investing in the stock of PartyWagon, Inc. You expect a dividend of $1.25 next year, $1.31 in year 2, and $1.38 in year 3. At the end of three years, you expect to be able to sell the stock for $65. If you can purchase the stock for $32, what rate of return do you expect to earn
Answer: 29.93%
Explanation:
You can use Excel to solve for this.
Bear in mind that when given a series of cashflows, the expected return is the Internal Rate of Return (IRR).
Initial investment = $32
First cashflow = $1.25
Second cashflow = $1.31
Third cashflow = $1.38 + $65 selling price = $66.38
IRR = 29.93%
A trust has been established to fund scholarships in perpetuity. The next annual distribution will be $1,200, and future payments will increase by 3 percent per year. What is the value of this trust at a discount rate of 7.4 percent
Answer:
PV= $27,272.73
Explanation:
Giving the following information:
Annual distribution (Cf)= $1,200
Interest rate (i)= 7.4% = 0.074
Growth rate (g)= 3% = 0.03
To calculate the present value (PV) of the fund, we need to use the following formula:
PV= Cf / (i - g)
PV= 1,200 / (0.074 - 0.03)
PV= $27,272.73
On January 2, 2021, L Co. issued at face value $22,000 of 3% bonds convertible in total into 1,400 shares of L's common stock. No bonds were converted during 2021. Throughout 2021, L had 1,400 shares of common stock outstanding. L's 2021 net income was $4,000. L's income tax rate is 30%. No potential common shares other than the convertible bonds were outstanding during 2021. L's diluted earnings per share for 2021 would be:
Vincent corporation has 100,00 shares of 100 par common stock outstanding. on june30 ,Vincent corporation declared a 5% stock dividend to be issued on July 30 to stockholders of record july15. the market price of the stock was $132 a share on June 30. journalize the entries required on June 30 and july30
The common stock that is seen here would be $500000
What is the common stock outstanding?This is the term that would simply be used to refer to all of the shares that the shareholders of a company as well as the people that are the insiders in the company would own.
How to solve for the journal entriesThe retained earnings is given as
$132 * 0.05
= $6.6
= 6.6 x 100000
= 660000
The debit is $660000
The credit is 100000 x 5 = 500000
paid in capital in excess of par = 660000 - 500000
= $160000
The stock dividend distributable = $500000
common stock is given as $500000
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(a) A lamp has two bulbs of a type with an average lifetime of 1800 hours. Assuming that we can model the probability of failure of these bulbs by an exponential density function with mean μ = 1800, find the probability that both of the lamp's bulbs fail within 2000 hours.
(b) Another lamp has just one bulb of the same type as in part (a). If one bulb burns out and is replaced by a bulb of the same type, find the probability that the two bulbs fail within a total of 1000 hours.
Answer:
a) 0.45
b) 0.11
Explanation:
A) P( both bulbs fail within 2000 hours ) = 0.45
Given data:
Average lifetime of bulbs = 1800 hours
mean μ = 1800
b) P( both bulbs fail within 1000 hours ) =
Attached below is a detailed solution of the given question
A partial list of Waterways' accounts and their balances for the month of November 2016 follows:
Accounts Receivable $ 275,000
Advertising Expenses 54,000
Cash 260,000
Depreciation-Factory Equipment 16,800
Depreciation-Office Equipment 2,400
Direct Labor 42,000
Factory Supplies Used 16,800
Factory Utilities 10,200
Finished Goods Inventory, November 30 68,800
Finished Goods Inventory, October 31 72,550
Indirect Labor 48,000
Office Supplies Expense 1,600
Other Administrative Expenses 72,000
Prepaid Expenses 41,250
Raw Materials Inventory, November 30 52,700
Raw Materials Inventory, October 31 38,000
Raw Materials Purchases 184,500
Rent Factory Equipment 47,000
Repairs-Factory Equipment 4,500
Salaries 325,000
A list of accounts and their values are given above. From this information, prepare a partial balance sheet for Waterways Corporation for the month of November. (List Current Assets in order of liquidity.)
Answer:
Total current assets = $697,750
Explanation:
The partial balance sheet is as follows:
Waterways Corporation
Balance Sheet (Partial)
For the month of November 2016
Details $ $
Current Assets
Cash 260,000
Accounts Receivable 275,000
Finished Goods Inventory, November 68,800
Raw Materials Inventory, November 52,700
Prepaid Expenses 41,250
Total current assets 697,750
Note:
Cash is the most liquid of assets.
Accounts receivable which should be collected within 30 to 60 days are less liquid than cash, but more liquid than inventory.
Finished Goods Inventory which is expected to be sold and converted to cash within one year, and Raw Materials Inventory which is expected to be converted to finished good within one year are more liquid than Prepaid expense.
Therefore, the least liquid among current assets’ item above is the Prepaid Expense as it is cash paid for services not yet received..
In his work Divine Comedy, the 14-century Italian poet Dante described a trip into space. As he traveled away from Earth, he visited the following celestial bodies in order: the moon, Mercury, Venus, the sun, Jupiter, and Saturn. What view of solar system structure did Dante hold? How do you know? Compare this view with a modern understanding of the solar system’s structure.
According to Italian poet Dante;
Dante believed in a geocentric conception of the planetary system, wherein the Earth seems to be at the centre while the moon, sun, and other planets revolve around it.
Explanation:
Researchers understand Dante had a geocentric perspective of the solar system since he would have visited Venus earlier Mercury in a sun-centered worldview.According to Dante's interpretation of the solar system, the crescent, sun, and planet all revolve around Earth. According to current thinking, only the moon revolves Earth; the Earth and then all the planets remain in orbit of sun.Learn more:
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The ultimate goal of contract damages is: Multiple Choice Put the nonbreaching party where it was before the contract was formed. Return any costs incurred by the nonbreaching party. Put the nonbreaching party where it was prior to breach. Put the nonbreaching party in the best position possible. Give the nonbreaching party the benefit of its bargain.
Answer:
Give the nonbreaching party the benefit of its bargain.
Explanation:
A contract can be defined as an agreement between two or more parties (group of people) which gives rise to a mutual legal obligation or enforceable by law.
There are different types of contract in business and these includes: fixed-price contract, cost-plus contract, bilateral contract, implies contract, unilateral contract, adhesion contract, unconscionable contract, option contract, express contract, executory contract, etc.
Mutual assent is a legal term which represents an agreement by both parties to a contract. When two parties to a contract both have an understanding of the parameters, terms and conditions surrounding a contract, it ultimately implies that they are in agreement; this is generally referred to as mutual assent.
In contract law, damages can be defined as an amount of money that is paid to a claimant (innocent party) as a compensation for a breach of contractual agreement and it's based on the amount of interest he or she has vested in the contract. Thus, it covers the incurred by the nonbreaching party (claimant or innocent party) due to a breach of contract by the other party.
Hence, the ultimate goal of contract damages is to give the nonbreaching party the benefit of its bargain.
Last year, you purchased a stock at a price of $64.00 a share. Over the course of the year, you received $2.20 per share in dividends and inflation averaged 2.7 percent. Today, you sold your shares for $69.00 a share. What is your approximate real rate of return on this investment
Answer:
8.55%
Explanation:
Calculation to determine your approximate real rate of return on this investment
First step is to calculate the Nominal return
Nominal return = ($69 - $64+ $2.20)/$64
Nominal return=7.2/$64
Nominal return= 0.1125
Now let calculate the Approximate real return
Approximate real return = 0.1125 - 0.027
Approximate real return= 0.0855*100
Approximate real return=8.55%
Therefore your approximate real rate of return on this investment is 8.55%
Various financial data for the past two years follow. LAST YEAR THIS YEAR Output: Sales $ 200,200 $ 202,000 Input: Labor 30,005 40,005 Raw materials 34,500 44,500 Energy 5,000 6,100 Capital 48,990 48,990 Other 2,000 3,005 a. Calculate the total productivity measure for this company for both years.
Answer:
The total productivity measures for this company for both years are:
LAST YEAR THIS YEAR
Total productivity 1.66 1.42
Explanation:
a) Data and Calculations:
LAST YEAR THIS YEAR
Output: Sales $ 200,200 $ 202,000
Input: Labor 30,005 40,005
Raw materials 34,500 44,500
Energy 5,000 6,100
Capital 48,990 48,990
Other 2,000 3,000
Total input 120,495 142,595
Total productivity = Output/Input
= $ 200,200/120,495 $ 202,000/142,595
= 1.66 1.42
Complete the following statements with one of the terms listed here. You may use a term more than once. Some terms may not be used at all. Capital turnover Direct fixed expenses Flexible budget variance Key performance indictors (KPIs) Profit center Sales margin Common fixed expenses Favorable variance Goal congruence Management by exception Return on investment (ROI) Unfavorable variance Cost center Flexible budget Investment center Master budget variance Revenue center Volume variance
Solution :
a). Flexible budget
A flexible budget is a budget that is prepared for the different volume level which was originally anticipated.
b). Flexible budget variance
It is the different between the flexible budget and the actual results.
c). Return on Investment
It is used to evaluate the performance of the investment centers. It is calculated by dividing operating income by the investment.
d). Favorable variance
The company has the favorable variance when the actual values are more than the budgeted values.
S. Wang and T. Wu are partners with equal capital balances of $50,000 each. They agree to let J. Li invest $20,000 in their partnership for a 10% interest, including bonuses to the existing partners. The journal entry to reflect the bonus to Wang will include a credit to _______ in the amount of ______.
The journal entry to reflect the bonus to Wang will include a credit to Wang, Capital in the amount of $4,000
First step is to calculate S. Wang and T. Wu and J. Li capital amount
Capital=$50,000+$50,000+$20,000
Capital=$120,000
Second step is to calculate their new capital
New capital=$120,000*.10
New capital=$12,000
Now to determine Wang bonus amount we have to divide the capital equally between S. Wang and T. Wu
Bonus=($20,000-$12,000)/2
Bonus=$8,000/2
Bonus=$4,000
Therefore journal entry to reflect the bonus to Wang will include a credit to Wang, Capital in the amount of $4,000
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PlZ Help 70 points
Look at the circular flow diagram. Choose and define an environmental issue. Using the diagram as a guide, explain how the environmental issue you chose affects the relationship between the business and factor market. (4 points)
Answer:
Family and government are related to each other in terms of financial unit. Family pay charges to government and after that government utilize that cash for the individuals. Family gain the money by working in firms or by running their possess commerce. Natural issues such as discuss contamination can influence the relationship between family and government. Popleuses their possess transport to go to firms and the number of vehicles are expanding day by day which causes discuss contamination. The government can shape arrangements against personal transport and persuade individuals to utilize open transport which can be advantageous for government as government will straightforwardly get cash from family.
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Merchant Company issued 10-year bonds on January 1. The 6% bonds have a face value of $727,000 and pay interest every January 1 and July 1. The bonds were sold for $604,217 based on the market interest rate of 7%. Merchant uses the effective interest rate method to amortize bond discounts and premiums. On July 1 of the first year, Merchant should record interest expense (rounded to the nearest dollar) of
Answer:
Merchant Company
On July 1 of the first year, Merchant should record interest expense (rounded to the nearest dollar) of:
= $22,472.
Explanation:
a) Data and Calculations:
Face value of bonds = $727,000
Price of bonds = 604,217
Discounts = $122,783
Period of bonds = 10 years
Coupon rate of interest = 6%
Market interest rate = 7%
Payment of interest = Semi-annually (Jan. 1 and July 1)
July 1:
Cash payment = $21,810 ($727,000 * 3%)
Interest based on market rate = 21,148 ($604,217 * 3.5%)
Discount amortization = $662
Interest expense = $22,472 ($21,810 + $662)
Gotiable sells straw hats for $24 each. The April inventory purchases are summarized below. Gotiable sold 142 hats at a hat festival on April 28. Units Cost each Dollars Beg. Inv. 84 3 252 April 2 75 4 300 April 14 66 7 462 April 23 52 8 416
Assume that Gotiable uses the average cost method for inventory costing.
1. What is the average cost of one hat? (Round to the nearest penny (2 decimal points)).
2. What will be the dollar value of the inventory on the April 30th balance Sheet? (Round to the nearest dollar)
3. What will Gotiable report as Gross margin for the hats for the month of April? (Round to the nearest dollar)
Answer and Explanation:
The computation is shown below:
1.
Particulars Units Unit Cost Dollars
Beg. Inv. 84 $3 $252
Apr-02 75 $4 $300
Apr-14 66 $7 $462
Apr-23 52 $8 $416
Total 277 $1,430
Average cost of one hat is
= Total cost of purchases ÷ Units purchased
= $1,430 ÷ 277 units
= $5.16
2.
Ending Inventory in Units = Units purchased - Units sold
= 277 units - 142 units
= 135 units
Now
Value of Ending Inventory = Units in Ending Inventory × Average cost per unit
= 135 units × $5.16
= $696.60
= $697
3
Gross Margin = Units sold × (Selling Price - Cost of goods sold)
= 142 units × ($24 - $5.16)
= $2,675.28
= $2,675
Variable costs as a percentage of sales for Lemon Inc. are 71%, current sales are $551,000, and fixed costs are $207,000. How much will operating income change if sales increase by $37,600? a.$10,904 increase b.$26,696 decrease c.$26,696 increase d.$10,904 decrease
Answer: a.$10,904 increase
Explanation:
Operating income before sales increase:
= Sales - Variable costs - Fixed costs
= 551,000 - (71% * 551,000) - 207,000
= -$47,210
Operating income after sales increase:
Sales increases to:
= 551,000 + 37,600
= $588,600
= 588,600 - (71% * 588,600) - 207,000
= -$36,306
Difference:
= -47,210 - (-36,306)
= Increase of $10,904
A firm has estimated Free Cash Flows of $300,000, $310,000 and $360,000 for the next three (3) years. If this firm has a WACC of 9.40% and expects these cash flows to grow by 2.10% in perpetuity, then what is the Terminal Value of these expected perpetual cash flows.
Answer: $5,035,068.49
Explanation:
Terminal value is calculated based on the last cashflow and the growth rate in perpetuity.
The Gordon Growth Model is best used here:
= Free Cash Flow₄ / (WACC - Growth rate)
= (FCF₃ * (1 + growth rate) ) / (WACC -Growth rate)
= (360,000 * (1 + 2.10%)) / (9.40% - 2.10%)
= 367,560 / 7.3%
= $5,035,068.49
A company's overhead rate is 60% of direct labor cost. Using the following incomplete accounts, determine the cost of direct materials used.
Goods in process inventory:
Beginning balance $100,800
D.M.
D.L.
O.H. F.G.
Ending balance $131,040
Answer: $113,120
Explanation:
Direct material used = Total cost of manufacturing - Direct labor - Factory overhead
Total cost of manufacturing = Ending WIP + Cost of manufacturing - Beginning WIP
= 131,040 + 324,800 - 100,800
= $355,040
Direct labor = Factory overhead * 100/60
= 90,720 * 100/60
= $151,200
Direct materials used = 355,040 - 151,200 - 90,720
= $113,120
The difference between actual overhead costs incurred and the budgeted overhead costs based on a flexible budget is the: Multiple Choice Production variance. Controllable variance. Volume variance. Price variance. Quantity variance.
The difference between actual overhead costs incurred and the budgeted overhead costs based on a flexible budget is the controllable variance.
In accounting, there are two elements of a variance- rate variance and volume variance. While the rate variance refers to the difference in the actual price paid vs. the budgeted price, the volume variance refers to the portion of the variance in sales, unit usage.
The controllable variance is in the "rate" element of the variance.Controllable variance refers to the process by which the efficiency of using variable overhead resources is measured.This means that the controllable variance is the difference between the actual cost and the budgeted overhead cost.The calculation for this variance is: Actual overhear expense - (budgeted overhead cost x standard number of units)= overhead controllable variance.In short, we can say that the controllable variance is the amount that is not part of the volume variance. Rather, it is the difference in the overhead cost incurred and the budgeted overhead cost.
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g provides the following income statement for 20X9: Net Sales $240,000 Cost of Goods Sold 110,000 Gross Profit $130,000 Operating Expenses: Selling Expenses 45,000 Administrative Expenses 12,000 Total Operating Expenses 57,000 Operating Income $73,000 Other Income and (Expenses): Loss on Sale of Capital Assets (29,000) Interest Expense (1000) Total Other Income and (Expenses) (30,000) Income Before Income Taxes $43,000 Income Tax Expense 5000 Net Income $38,000 Calculate the times-interest-earned ratio.
Answer: 44 times
Explanation:
Times interest earned ratio aims to show just how much the company is able to cover its interest obligations using its operating income.
Times interest earned ratio = Net income before interest / Interest expense
Net income before interest = Operating income loss on sale of capital assets
= 73,000 - 29,000
= $44,000
Times interest earned ratio = 44,000 / 1,000
= 44 times
You have just made your first $5,837 contribution to your retirement account. Assume you earn a return of 9.8 percent per year and make no additional contributions. What will your account be worth when you retire in 45 years
Bramble Corp.’s cost of goods sold is $280000 variable and $170000 fixed. The company’s selling and administrative expenses are $160000 variable and $220000 fixed. If the company’s sales is $1080000, what is its net income?
Answer:
the net income is $250,000
Explanation:
The computation of the net income is given below:
= Sales - variable cost of goods sold - fixed cost of goods sold - variable selling & admin expense - fixed selling & admin expense
= $1,080,000 - $280,000 - $170,000 - $160,000 - $220,000
= $250,000
Hence, the net income is $250,000
The above formula should be applied for the same
Payroll Entries
The payroll register for D. Salah Company for the week ended May 18 indicated the following:
Salaries $615,000
Federal income tax withheld 165,000
The salaries were all subject to the 6.0% social security tax and the 1.5% Medicare tax. In addition, state and federal unemployment taxes were calculated at the rate of 5.4% and 0.8%, respectively, on $45,000 of salaries.
For a compound transaction, if an amount box does not require an entry, leave it blank.
a. Journalize the entry to record the payroll for the week of May 18.
May 18 Salaries Expense
Social Security Tax Payable
Medicare Tax Payable
Employees Federal Income Tax Payable
Salaries Payable
Feedback
Gross pay is the amount that employees have earned before taxes and deductions. A portion of employees' earnings are owed for such items as state and federal taxes. Net pay is also known as take-home pay.
b. Journalize the entry to record the payroll tax expense incurred for the week of May 18.
May 18 Payroll Tax Expense
Social Security Tax Payable
Medicare Tax Payable
State Unemployment Tax Payable
Federal Unemployment Tax Payable
Answer:
A. Dr Salaries expense 615000
Cr Social security tax payable 36900
Cr Medicare tax payable 9225
Cr Employment federal income tax payable
165000
Cr Salaries payable 403875
B. Dr Payroll tax expenses 48915
Cr Social security tax payable 36900
Cr Medicare tax payable 9225
Cr State unemployment taxes payable 2430
Cr Federal unemployment taxes payable 360
Explanation:
A. Preparation of the journal entry to record the payroll for the week of May 18.
May 18
Dr Salaries expense 615000
Cr Social security tax payable 36900
(615000*6%)
Cr Medicare tax payable 9225
(615000*1.5%)
Cr Employment federal income tax payable
165000
Cr Salaries payable 403875
(615000-36900-9225-165000)
(To record the payroll for the week of May 18)
B. Preparation of the journal entry to record the payroll tax expense incurred for the week of May 18
May 18
Dr Payroll tax expenses 48915
(36900+9225+2430+360)
Cr Social security tax payable 36900
(615000*6%)
Cr Medicare tax payable 9225
(615000*1.5%)
Cr State unemployment taxes payable 2430
(45000*5.4%)
Cr Federal unemployment taxes payable 360
(45000*0.8%)
(To record the payroll tax expense incurred )
Question 18
What would be the best appraisal approach to use in estimating the market value of an athletic stadium?
a) Sales comparison
b) Cost
c) Direct capitalization
d) Yield capitalization
Answer:
It's option B. cost
I recently learned about it in my marketing course.
Colorado Cleaning has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new washing machine and must choose between two alternative ones. The first machine requires an initial investment of $25,000 and generates annual after-tax cash inflows of $6,500 for each of the next 8 years. The second machine requires an initial investment of $75,000 and provides an annual cash inflow after taxes of $9,500 for 15 years.
Required:
a. Determine the payback period for each machine.
b. Comment on the acceptability of the machines, assuming that they are independent projects.
c. Which machine should the firm accept? Why?
d. Do the machines in this problem illustrate any of the weaknesses of using payback? Discuss.
Answer:
a) Payback period = period up to which cumulative cash flow is negative +
(negative cumulative cash flow /cash flow succeeding
the above period)
Project A - Up to year 4 ,cash flow recovered = 3000 * 4 = 12,000
Payback period =14,000/3,000 = 4.67 years
Project B= Cash flow recovered up to year 5 = 4000 * 5 = 20000
Payback period = 21,000/4,000 =5.25 years
b) On the basis of the Payback period, Project A should be selected, as it has a lower payback period and is also within the maximum acceptable payback period. back period.(4.67 < 5)
Project B should not be selected as its payback recovery is not within the maximum acceptable payback period (5.25 >5 )
c) Machine A should be selected as it has a lower payback period. than machine B.
d)The payback period ignores the life present value of cash flow and also the life of the machine each project has.
so the decision on the basis of the payback period may not be accurate.
Assume that an analyst is using the constant dividend growth model to value a stock. Which of the following scenarios would be certain to cause her to decrease her estimate of the stock's value (assuming, of course, that all other factors are held constant)?
A. She believes the company has become riskier, and therefore increases her required rate of return for the stock.
B. She increases her estimate of the company’s next year’s dividend.
C. She increase her estimate of the expected annual rate of growth in the company’s dividends.
D. She decreases her required rate of return for the stock.
E. None of the above would cause her to decrease her estimate of the stock’s value.
Answer: A. She believes the company has become riskier, and therefore increases her required rate of return for the stock.
Explanation:
The formula for the Constant dividend growth model of valuing stock is:
= Next dividend / (Required return - growth rate)
From the formula above, one can tell that if the required return is higher, it would result in a lower value for stock because it would divide the numerator more.
If the analyst believes that the company is riskier and increases the required return, the value would therefore reduce if other measures are kept constant.
