Use of dividend discount models

EIFM Seminar 10 – week commencing Dec 13th 2021

Question 1: At Litchfield Chemical Corp., a director of the company said that the use of dividend discount models by investors is “proof” that the higher the dividend, the higher the stock price.

a. Using a constant-growth dividend discount model as a basis of reference, evaluate the directors’ statement.

b. Explain how an increase in dividend payout would affect each of the following (holding all other factors constant):

i. Sustainable growth rate.

ii. Growth in book value.



Question 2: Low Tech Chip Company is expected to have EPS in the coming year of $2.50. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, what is the intrinsic value of the stock?  

Question 3: Discuss the relationships between the required rate of return on a stock, the firm’s return on equity, the plowback rate, the growth rate, and the value of the firm.

Question 4: Discuss the various forms of market efficiency. Include in your discussion the information sets involved in each form and the relationships across information sets and across forms of market efficiency. Also discuss the implications for the various forms of market efficiency for the various types of securities’ analysts. 

Question 5: The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight, during the peak of the citrus harvest. In an efficient market one would expect the price of Florida Orange’s stock to

A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.

Question 6: Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that

A. bad news about Matthews was announced yesterday.
B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.

Question 7: If stock prices follow a random walk

A. it implies that investors are irrational.
B. it means that the market cannot be efficient.
C. price levels are not random.
D. price changes are random.
E. price movements are predictable.

Question 8: Proponents of the EMH typically advocate

A. buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
C. a passive investment strategy.
D. buying individual stocks on margin and trading frequently and investing in hedge funds
E. investing in hedge funds and a passive investment strategy